Title 26

Internal Revenue Part 1 (1.501 to 1.640) Revised as of April 1, 2013 Containing a codification of documents of general applicability and future effect As of April 1, 2013 Published by the Office of the Federal Register National Archives and Records Administration as a Special Edition of the Federal Register VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00001 Fmt 8091 Sfmt 8091 Q:\26\26V7.TXT ofr150 PsN: PC150U.S. GOVERNMENT OFFICIAL EDITION NOTICE Legal Status and Use of Seals and Logos The seal of the National Archives and Records Administration (NARA) authenticates the Code of Federal Regulations (CFR) as the official codification of Federal regulations established under the Federal Register Act. Under the provisions of 44 U.S.C. 1507, the contents of the CFR, a special edition of the Federal Register, shall be judicially noticed. The CFR is prima facie evidence of the origi-nal documents published in the Federal Register (44 U.S.C. 1510). 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GOVERNMENT PRI NTI NG OFFI CE U.S. Superintendent of Documents Washington, DC 204020001 http://bookstore.gpo.gov Phone: toll-free (866) 512-1800; DC area (202) 512-1800 VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00002 Fmt 8092 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150archives.ai</GPH>gpologo.eps</GPH>iii Table of Contents Page Explanation ................................................................................................ v Title 26: Chapter IInternal Revenue Service, Department of the Treasury (Continued) .................................................................................. 3 Finding Aids: Table of CFR Titles and Chapters ....................................................... 563 Alphabetical List of Agencies Appearing in the CFR ......................... 583 Table of OMB Control Numbers .......................................................... 593 List of CFR Sections Affected ............................................................. 611 VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00003 Fmt 8092 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150iv Cite this Code: CFR To cite the regulations in this volume use title, part and section num-ber. Thus, 26 CFR 1.501(a)1 refers to title 26, part 1, section 501(a)1. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00004 Fmt 8092 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150v Explanation The Code of Federal Regulations is a codification of the general and permanent rules published in the Federal Register by the Executive departments and agen-cies of the Federal Government. The Code is divided into 50 titles which represent broad areas subject to Federal regulation. Each title is divided into chapters which usually bear the name of the issuing agency. Each chapter is further sub-divided into parts covering specific regulatory areas. Each volume of the Code is revised at least once each calendar year and issued on a quarterly basis approximately as follows: Title 1 through Title 16..............................................................as of January 1 Title 17 through Title 27 .................................................................as of April 1 Title 28 through Title 41 ..................................................................as of July 1 Title 42 through Title 50.............................................................as of October 1 The appropriate revision date is printed on the cover of each volume. LEGAL STATUS The contents of the Federal Register are required to be judicially noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie evidence of the text of the original documents (44 U.S.C. 1510). HOW TO USE THE CODE OF FEDERAL REGULATIONS The Code of Federal Regulations is kept up to date by the individual issues of the Federal Register. These two publications must be used together to deter-mine the latest version of any given rule. To determine whether a Code volume has been amended since its revision date (in this case, April 1, 2013), consult the List of CFR Sections Affected (LSA), which is issued monthly, and the Cumulative List of Parts Affected, which appears in the Reader Aids section of the daily Federal Register. These two lists will identify the Federal Register page number of the latest amendment of any given rule. EFFECTIVE AND EXPIRATION DATES Each volume of the Code contains amendments published in the Federal Reg-ister since the last revision of that volume of the Code. Source citations for the regulations are referred to by volume number and page number of the Federal Register and date of publication. Publication dates and effective dates are usu-ally not the same and care must be exercised by the user in determining the actual effective date. In instances where the effective date is beyond the cut- off date for the Code a note has been inserted to reflect the future effective date. In those instances where a regulation published in the Federal Register states a date certain for expiration, an appropriate note will be inserted following the text. OMB CONTROL NUMBERS The Paperwork Reduction Act of 1980 (Pub. L. 96511) requires Federal agencies to display an OMB control number with their information collection request. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00005 Fmt 8008 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150vi Many agencies have begun publishing numerous OMB control numbers as amend-ments to existing regulations in the CFR. These OMB numbers are placed as close as possible to the applicable recordkeeping or reporting requirements. PAST PROVISIONS OF THE CODE Provisions of the Code that are no longer in force and effect as of the revision date stated on the cover of each volume are not carried. Code users may find the text of provisions in effect on any given date in the past by using the appro-priate List of CFR Sections Affected (LSA). For the convenience of the reader, a List of CFR Sections Affected is published at the end of each CFR volume. For changes to the Code prior to the LSA listings at the end of the volume, consult previous annual editions of the LSA. For changes to the Code prior to 2001, consult the List of CFR Sections Affected compilations, published for 1949- 1963, 1964-1972, 1973-1985, and 1986-2000. [RESERVED] TERMINOLOGY The term [Reserved] is used as a place holder within the Code of Federal Regulations. An agency may add regulatory information at a [Reserved] loca-tion at any time. Occasionally [Reserved] is used editorially to indicate that a portion of the CFR was left vacant and not accidentally dropped due to a print-ing or computer error. INCORPORATION BY REFERENCE What is incorporation by reference? Incorporation by reference was established by statute and allows Federal agencies to meet the requirement to publish regu-lations in the Federal Register by referring to materials already published else-where. For an incorporation to be valid, the Director of the Federal Register must approve it. The legal effect of incorporation by reference is that the mate-rial is treated as if it were published in full in the Federal Register (5 U.S.C. 552(a)). This material, like any other properly issued regulation, has the force of law. What is a proper incorporation by reference? The Director of the Federal Register will approve an incorporation by reference only when the requirements of 1 CFR part 51 are met. Some of the elements on which approval is based are: (a) The incorporation will substantially reduce the volume of material pub-lished in the Federal Register. (b) The matter incorporated is in fact available to the extent necessary to afford fairness and uniformity in the administrative process. (c) The incorporating document is drafted and submitted for publication in accordance with 1 CFR part 51. What if the material incorporated by reference cannot be found? If you have any problem locating or obtaining a copy of material listed as an approved incorpora-tion by reference, please contact the agency that issued the regulation containing that incorporation. If, after contacting the agency, you find the material is not available, please notify the Director of the Federal Register, National Archives and Records Administration, 8601 Adelphi Road, College Park, MD 20740-6001, or call 202-741-6010. CFR INDEXES AND TABULAR GUIDES A subject index to the Code of Federal Regulations is contained in a separate volume, revised annually as of January 1, entitled CFR INDEX AND FINDING AIDS. This volume contains the Parallel Table of Authorities and Rules. A list of CFR titles, chapters, subchapters, and parts and an alphabetical list of agencies pub-lishing in the CFR are also included in this volume. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00006 Fmt 8008 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150vii An index to the text of Title 3The President is carried within that volume. The Federal Register Index is issued monthly in cumulative form. This index is based on a consolidation of the Contents entries in the daily Federal Reg-ister. A List of CFR Sections Affected (LSA) is published monthly, keyed to the revision dates of the 50 CFR titles. REPUBLICATION OF MATERIAL There are no restrictions on the republication of material appearing in the Code of Federal Regulations. INQUIRIES For a legal interpretation or explanation of any regulation in this volume, contact the issuing agency. The issuing agencys name appears at the top of odd-numbered pages. For inquiries concerning CFR reference assistance, call 2027416000 or write to the Director, Office of the Federal Register, National Archives and Records Administration, 8601 Adelphi Road, College Park, MD 20740-6001 or e-mail fedreg.info@nara.gov. SALES The Government Printing Office (GPO) processes all sales and distribution of the CFR. For payment by credit card, call toll-free, 866-512-1800, or DC area, 202- 512-1800, M-F 8 a.m. to 4 p.m. e.s.t. or fax your order to 202-512-2104, 24 hours a day. For payment by check, write to: US Government Printing Office New Orders, P.O. Box 979050, St. Louis, MO 63197-9000. ELECTRONIC SERVICES The full text of the Code of Federal Regulations, the LSA (List of CFR Sections Affected), The United States Government Manual, the Federal Register, Public Laws, Public Papers of the Presidents of the United States, Compilation of Presi-dential Documents and the Privacy Act Compilation are available in electronic format via www.ofr.gov. For more information, contact the GPO Customer Con-tact Center, U.S. Government Printing Office. Phone 202-512-1800, or 866-512-1800 (toll-free). E-mail, ContactCenter@gpo.gov. The Office of the Federal Register also offers a free service on the National Archives and Records Administrations (NARA) World Wide Web site for public law numbers, Federal Register finding aids, and related information. Connect to NARAs web site at www.archives.gov/federal-register. The e-CFR is a regularly updated, unofficial editorial compilation of CFR ma-terial and Federal Register amendments, produced by the Office of the Federal Register and the Government Printing Office. It is available at www.ecfr.gov. CHARLES A. BARTH, Director, Office of the Federal Register. April 1, 2013. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00007 Fmt 8008 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00008 Fmt 8008 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150ix THIS TITLE Title 26INTERNAL REVENUE is composed of twenty volumes. The contents of these volumes represent all current regulations issued by the Internal Revenue Service, Department of the Treasury, as of April 1, 2013. The first thirteen vol-umes comprise part 1 (Subchapter AIncome Tax) and are arranged by sections as follows: 1.01.60; 1.611.169; 1.1701.300; 1.3011.400; 1.4011.440; 1.441 1.500; 1.5011.640; 1.6411.850; 1.8511.907; 1.9081.1000; 1.10011.1400; 1.1401 1.1550; and 1.1551 to end of part 1. The fourteenth volume containing parts 2 29, includes the remainder of subchapter A and all of Subchapter BEstate and Gift Taxes. The last six volumes contain parts 3039 (Subchapter CEmployment Taxes and Collection of Income Tax at Source); parts 4049; parts 50299 (Sub-chapter DMiscellaneous Excise Taxes); parts 300499 (Subchapter FProcedure and Administration); parts 500599 (Subchapter GRegulations under Tax Con-ventions); and part 600 to end (Subchapter HInternal Revenue Practice). The OMB control numbers for Title 26 appear in 602.101 of this chapter. For the convenience of the user, 602.101 appears in the Finding Aids section of the volumes containing parts 1 to 599. For this volume, Jonn V. Lilyea was Chief Editor. The Code of Federal Regula-tions publication program is under the direction of Michael L. White, assisted by Ann Worley. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00009 Fmt 8092 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC150VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00010 Fmt 8092 Sfmt 8092 Q:\26\26V7.TXT ofr150 PsN: PC1501 Title 26Internal Revenue (This book contains part 1, 1.501 to 1.640) Part CHAPTER IInternal Revenue Service, Department of the Treasury (Continued) ......................................................... 1 VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00011 Fmt 8008 Sfmt 8008 Q:\26\26V7.TXT ofr150 PsN: PC150VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00012 Fmt 8008 Sfmt 8008 Q:\26\26V7.TXT ofr150 PsN: PC1503 CHAPTER IINTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) EDITORIAL NOTE: IRS published a document at 45 FR 6088, Jan. 25, 1980, deleting statutory sections from their regulations. In chapter I, cross references to the deleted material have been changed to the corresponding sections of the IRS Code of 1954 or to the appropriate regu-lations sections. When either such change produced a redundancy, the cross reference has been deleted. For further explanation, see 45 FR 20795, Mar. 31, 1980. SUBCHAPTER AINCOME TAX (CONTINUED) Part Page 1 Income taxes (Continued) ........................................ 5 SUPPLEMENTARY PUBLICATIONS: Internal Revenue Service Looseleaf Regulations System. Additional supplementary publications are issued covering Alcohol and Tobacco Tax Regula-tions, and Regulations Under Tax Conventions. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00013 Fmt 8008 Sfmt 8008 Q:\26\26V7.TXT ofr150 PsN: PC150VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00014 Fmt 8008 Sfmt 8008 Q:\26\26V7.TXT ofr150 PsN: PC1505 SUBCHAPTER AINCOME TAX (CONTINUED) PART 1INCOME TAXES (CONTINUED) NORMAL TAXES AND SURTAXES (CONTINUED) Exempt Organizations General Rule Sec. 1.501(a)1 Exemption from taxation. 1.501(c)(2)1 Corporations organized to hold title to property for exempt organiza-tions. 1.501(c)(3)1 Organizations organized and op-erated for religious, charitable, sci-entific, testing for public safety, literary, or educational purposes, or for the pre-vention of cruelty to children or animals. 1.501(c)(4)1 Civic organizations and local associations of employees. 1.501(c)(5)1 Labor, agricultural, and horti-cultural organizations. 1.501(c)(6)1 Business leagues, chambers of commerce, real estate boards, and boards of trade. 1.501(c)(7)1 Social clubs. 1.501(c)(8)1 Fraternal beneficiary societies. 1.501(c)(9)1 Voluntary employees bene-ficiary associations, in general. 1.501(c)(9)2 Membership in a voluntary em-ployees beneficiary association; employ-ees; voluntary association of employees. 1.501(c)(9)3 Voluntary employees bene-ficiary associations; life, sick, accident, or other benefits. 1.501(c)(9)4 Voluntary employees bene-ficiary associations; inurement. 1.501(c)(9)5 Voluntary employees bene-ficiary associations; recordkeeping re-quirements. 1.501(c)(9)6 Voluntary employees bene-ficiary associations; benefits includible in gross income. 1.501(c)(9)7 Voluntary employees bene-ficiary associations; section 3(4) of ERISA. 1.501(c)(9)8 Voluntary employees bene-ficiary associations; effective date. 1.501(c)(10)1 Certain fraternal beneficiary societies. 1.501(c)(12)1 Local benevolent life insur-ance associations, mutual irrigation and telephone companies, and like organiza-tions. 1.501(c)(13)1 Cemetery companies and crematoria. 1.501(c)(14)1 Credit unions and mutual in-surance funds. 1.501(c)(15)1 Mutual insurance companies or associations. 1.501(c)(16)1 Corporations organized to fi-nance crop operations. 1.501(c)(17)1 Supplemental unemployment benefit trusts. 1.501(c)(17)2 General rules. 1.501(c)(17)3 Relation to other sections of the Code. 1.501(c)(18)1 Certain funded pension trusts. 1.501(c)(19)1 War veterans organizations. 1.501(c)(21)1 Black lung trustscertain terms. 1.501(c)(21)2 Sametrust instrument. 1.501(c)(29)1T COOP Health Insurance Issuers (temporary). 1.501(d)1 Religious and apostolic associa-tions or corporations. 1.501(e)1 Cooperative hospital service orga-nizations. 1.501(h)1 Application of the expenditure test to expenditures to influence legislation; introduction. 1.501(h)2 Electing the expenditure test. 1.501(h)3 Lobbying or grass roots expendi-tures normally in excess of ceiling amount. 1.501(k)1 Communist-controlled organiza-tions. 1.5021 Feeder organizations. 1.503(a)1 Denial of exemption to certain or-ganizations engaged in prohibited trans-actions. 1.503(b)1 Prohibited transactions. 1.503(c)1 Future status of organizations de-nied exemption. 1.503(d)1 Cross references. 1.503(e)1 Special rules. 1.503(e)2 Requirements. 1.503(e)3 Effective dates. 1.503(e)4 Disallowance of charitable deduc-tions for certain gifts made before Janu-ary 1, 1970. 1.503(f)1 Loans by employers who are pro-hibited from pledging assets. 1.5041 Attempts to influence legislation; certain organizations formerly described in section 501(c)(3) denied exemption. 1.5042 Certain transfers made to avoid sec-tion 504(a). 1.505(c)1T Questions and answers relating to the notification requirement for rec-ognition of exemption under paragraphs (9), (17) and (20) of Section 501(c) (tem-porary). PRIVATE FOUNDATIONS 1.5071 General rule. 1.5072 Special rules; transfer to, or oper-ation as, public charity. 1.5073 Special rules; transferee founda-tions. 1.5074 Imposition of tax. 1.5075 Aggregate tax benefit; in general. 1.5076 Substantial contributor defined. 1.5077 Value of assets. 1.5078 Liability in case of transfers. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00015 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC1506 26 CFR Ch. I (4113 Edition) Pt. 1 1.5079 Abatement of taxes. 1.5081 Notices. 1.5082 Disallowance of certain charitable, etc., deductions. 1.5083 Governing instruments. 1.5084 Effective date. 1.509(a)1 Definition of private foundation. 1.509(a)2 Exclusion for certain organiza-tions described in section 170(b)(1)(A). 1.509(a)3 Broadly, publicly supported orga-nizations. 1.509(a)4 Supporting organizations. 1.509(a)4T Supporting organizations (tem-porary). 1.509(a)5 Special rules of attribution. 1.509(a)6 Classification under section 509(a). 1.509(a)7 Reliance by grantors and contrib-utors to section 509(a) (1), (2), and (3) or-ganizations. 1.509(b)1 Continuation of private founda-tion status. 1.509(c)1 Status of organization after ter-mination of private foundation status. 1.509(d)1 Definition of support. 1.509(e)1 Definition of gross investment in-come. TAXATION OF BUSINESS INCOME OF CERTAIN EXEMPT ORGANIZATIONS 1.5111 Imposition and rates of tax. 1.5112 Organizations subject to tax. 1.5113 Provisions generally applicable to the tax on unrelated business income. 1.5114 Minimum tax for tax preferences. 1.512(a)1 Definition. 1.512(a)2 Definition applicable to taxable years beginning before December 13, 1967. 1.512(a)3 [Reserved] 1.512(a)4 Special rules applicable to war veterans organizations. 1.512(a)5T Questions and answers relating to the unrelated business taxable income of organizations described in paragraphs (9), (17) or (20) of Section 501(c) (tem-porary). 1.512(b)1 Modifications. 1.512(c)1 Special rules applicable to part-nerships; in general. 1.5131 Definition of unrelated trade or busi-ness. 1.5132 Definition of unrelated trade or busi-ness applicable to taxable years begin-ning before December 13, 1967. 1.5133 Qualified convention and trade show activity. 1.5134 Certain sponsorship not unrelated trade or business. 1.5135 Certain bingo games not unrelated trade or business. 1.5136 Certain hospital services not unre-lated trade or business. 1.5137 Travel and tour activities of tax ex-empt organizations. 1.514(a)1 Unrelated debt-financed income and deductions. 1.514(a)2 Business lease rents and deduc-tions for taxable years beginning before January 1, 1970. 1.514(b)1 Definition of debt-financed prop-erty. 1.514(c)1 Acquisition indebtedness. 1.514(c)2 Permitted allocations under sec-tion 514(c)(9)(E). 1.514(d)1 Basis of debt-financed property acquired in corporate liquidation. 1.514(e)1 Allocation rules. 1.514(f)1 Definition of business lease. 1.514(g)1 Business lease indebtedness. FARMERS COOPERATIVES 1.5211 Farmers cooperative marketing and purchasing associations; requirements for exemption under section 521. 1.5221 Tax treatment of farmers coopera-tive marketing and purchasing associa-tions exempt under section 521. 1.5222 Manner of taxation of cooperative associations subject to section 522. 1.5223 Patronage dividends, rebates, or re-funds; treatment as to cooperative asso-ciations entitled to tax treatment under section 522. 1.5224 Taxable years affected. 1.5271 Political organizations; generally. 1.5272 Definitions. 1.5273 Exempt function income. 1.5274 Special rules for computation of po-litical organization taxable income. 1.5275 Activities resulting in gross income to an individual or political organiza-tion. 1.5276 Inclusion of certain amounts in the gross income of an exempt organization which is not a political organization. 1.5277 Newsletter funds. 1.5278 Effective date; filing requirements; and miscellaneous provisions. 1.5279 Special rule for principal campaign committees. HOMEOWNERS ASSOCIATIONS 1.5281 Homeowners associations. 1.5282 Organized and operated to provide for the acquisition, construction, man-agement, maintenance and care of asso-ciation property. 1.5283 Association property. 1.5284 Substantiality test. 1.5285 Source of income test. 1.5286 Expenditure test. 1.5287 Inurement. 1.5288 Election to be treated as a home-owners association. 1.5289 Exempt function income. 1.52810 Special rules for computation of homeowners association taxable income and tax. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00016 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC1507 Internal Revenue Service, Treasury Pt. 1 CORPORATIONS USED TO AVOID INCOME TAX ON SHAREHOLDERS Corporations Improperly Accumulating Surplus 1.5311 Imposition of tax. 1.5321 Corporations subject to accumulated earnings tax. 1.5331 Evidence of purpose to avoid income tax. 1.5332 Statement required. 1.5341 Burden of proof as to unreasonable accumulations generally. 1.5342 Burden of proof as to unreasonable accumulations in cases before the Tax Court. 1.5343 Jeopardy assessments in Tax Court cases. 1.5351 Definition. 1.5352 Adjustments to taxable income. 1.5353 Accumulated earnings credit. 1.5361 Short taxable years. 1.5371 Reasonable needs of the business. 1.5372 Grounds for accumulation of earn-ings and profits. 1.5373 Business of the corporation. PERSONAL HOLDING COMPANIES 1.5411 Imposition of tax. 1.5421 General rule. 1.5422 Gross income requirement. 1.5423 Stock ownership requirement. 1.5424 Corporations filing consolidated re-turns. 1.5431 Personal holding company income. 1.5432 Limitation on gross income and per-sonal holding company income in trans-actions involving stocks, securities, and commodities. 1.5441 Constructive ownership. 1.5442 Constructive ownership by reason of indirect ownership. 1.5443 Constructive ownership by reason of family and partnership ownership. 1.5444 Options. 1.5445 Convertible securities. 1.5446 Constructive ownership as actual ownership. 1.5447 Option rule in lieu of family and partnership rule. 1.5451 Definition. 1.5452 Adjustments to taxable income. 1.5453 Special adjustment to taxable in-come. 1.5471 General rule. 1.5472 Requirements for deficiency divi-dends. 1.5473 Claim for credit or refund. 1.5474 Effect on dividends paid deduction. 1.5475 Deduction denied in case of fraud or wilful failure to file timely return. 1.5476 Suspension of statute of limitations and stay of collection. 1.5477 Effective date. FOREIGN PERSONAL HOLDING COMPANIES 1.5511 General rule. 1.5512 Amount included in gross income. 1.5513 Deduction for obligations of the United States and its instrumentalities. 1.5514 Information in return. 1.5515 Effect on capital account of foreign personal holding company and basis of stock in hands of shareholders. 1.5521 Definition of foreign personal hold-ing company. 1.5522 Gross income requirement. 1.5523 Stock ownership requirement. 1.5524 Certain excluded banks. 1.5525 United States shareholder of ex-cluded bank. 1.5531 Foreign personal holding company income. 1.5541 Stock ownership. 1.5551 General rule. 1.5552 Additions to gross income. 1.5561 Definition. 1.5562 Adjustments to taxable income. 1.5563 Illustration of computation of undis-tributed foreign personal holding com-pany income. DEDUCTION FOR DIVIDENDS PAID 1.5611 Deduction for dividends paid. 1.5612 When dividends are considered paid. 1.5621 Dividends for which the dividends paid deduction is allowable. 1.5622 Preferential dividends. 1.5623 Distributions by a member of an af-filiated group. 1.5631 Accumulated earnings tax. 1.5632 Personal holding company tax. 1.5633 Dividends considered as paid on last day of taxable year. 1.5641 Dividend carryover. 1.5651 General rule. 1.5652 Limitations. 1.5653 Effect of consent. 1.5654 Consent dividends and other dis-tributions. 1.5655 Nonresident aliens and foreign cor-porations. 1.5656 Definitions. BANKING INSTITUTIONS Rules of General Application to Banking Institutions 1.5811 Banks. 1.5812 Mutual savings banks, building and loan associations, and cooperative banks. 1.5813 Definition of bank prior to Sep-tember 28, 1962. 1.5821 Bad debts, losses, and gains with re-spect to securities held by financial in-stitutions. 1.5841 Common trust funds. 1.5842 Income of participants in common trust fund. 1.5843 Computation of common trust fund income. 1.5844 Admission and withdrawal of par-ticipants in the common trust fund. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00017 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC1508 26 CFR Ch. I (4113 Edition) Pt. 1 1.5845 Returns of banks with respect to common trust funds. 1.5846 Net operating loss deduction. 1.5851 Reserve for losses on loans of banks. 1.5852 Addition to reserve. 1.5853 Special rules. 1.5854 Reorganizations and asset acquisi-tions. 1.5855 Denial of bad debt reserves for large banks. 1.5856 Recapture method of changing from the reserve method of section 585. 1.5857 Elective cut-off method of changing from the reserve method of section 585. 1.5858 Rules for making and revoking elec-tions under 1.5856 and 1.5857. 1.5861 Reserve for losses on loans of small business investment companies, etc. 1.5862 Addition to reserve. MUTUAL SAVINGS BANKS, ETC. 1.5911 Deduction for dividends paid on de-posits. 1.5921 Repayment of certain loans by mu-tual savings banks, building and loan as-sociations, and cooperative banks. 1.5931 Additions to reserve for bad debts. 1.5932 Additions to reserve for bad debts where surplus, reserves, and undivided profits equal or exceed 12 percent of de-posits or withdrawable accounts. 1.5933 Taxable years affected. 1.5934 Organizations to which section 593 applies. 1.5935 Addition to reserves for bad debts. 1.5936 Pre-1970 addition to reserve for losses on qualifying real property loans. 1.5936A Post-1969 addition to reserve for losses on qualifying real property loans. 1.5937 Establishment and treatment of re-serves for bad debts. 1.5938 Allocation of pre-1952 surplus to opening balance of reserve for losses on qualifying real property loans. 1.59310 Certain distributions to share-holders by a domestic building and loan association. 1.59311 Qualifying real property loan and nonqualifying loan defined. 1.5941 Mutual savings banks conducting life insurance business. 1.5951 Treatment of foreclosed property by certain creditors. 1.5961 Limitation on dividends received de-duction. 1.5971 Definitions. 1.5972 Taxation of Federal financial assist-ance. 1.5973 Other rules. 1.5974 Bridge Banks and Agency Control. 1.5975 Taxable Transfers. 1.5976 Limitation on collection of income tax. 1.5977 Effective date. 1.5978 Transitional rules for Federal finan-cial assistance. BANK AFFILIATES 1.6011 Special deduction for bank affiliates. NATURAL RESOURCES Deductions 1.6110 Regulatory authority. 1.6111 Allowance of deduction for deple-tion. 1.6112 Rules applicable to mines, oil and gas wells, and other natural deposits. 1.6113 Rules applicable to timber. 1.6114 Depletion as a factor in computing earnings and profits for dividend pur-poses. 1.6115 Depreciation of improvements. 1.6121 Basis for allowance of cost depletion. 1.6122 Allowable capital additions in case of mines. 1.6123 Depletion; treatment of bonus and advanced royalty. 1.6124 Charges to capital and to expense in case of oil and gas wells. 1.6125 Charges to capital and to expense in case of geothermal wells. 1.6131 Percentage depletion; general rule. 1.6132 Percentage depletion rates. 1.6133 Gross income from the property. 1.6134 Gross income from the property in the case of minerals other than oil and gas. 1.6135 Taxable income from the property. 1.6136 Statement to be attached to return when depletion is claimed on percentage basis. 1.6137 Application of percentage depletion rates provided in section 613(b) to certain taxable years ending in 1954. 1.613A0 Limitations on percentage deple-tion in the case of oil and gas wells; table of contents. 1.613A1 Post-1974 limitations on percentage depletion in case of oil and gas wells; general rule. 1.613A2 Exemption for certain domestic gas wells. 1.613A3 Exemption for independent pro-ducers and royalty owners. 1.613A4 Limitations on application of 1.613A3 exemption. 1.613A5 Election under section 613A(c)(4). 1.613A6 Recordkeeping requirements. 1.613A7 Definitions. 1.6140 Introduction. 1.6141 Definition of property. 1.6142 Election to aggregate separate oper-ating mineral interests under section 614(b) prior to its amendment by Revenue Act of 1964. 1.6143 Rules relating to separate operating mineral interests in the case of mines. 1.6144 Treatment under the Internal Rev-enue Code of 1939 with respect to sepa-rate operating mineral interests for tax-able years beginning before January 1, 1964, in the case of oil and gas wells. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00018 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC1509 Internal Revenue Service, Treasury 1.501(a)1 1.6145 Special rules as to aggregating non-operating mineral interests. 1.6146 Rules applicable to basis, holding pe-riod, and abandonment losses where min-eral interests have been aggregated or combined. 1.6147 Extension of time for performing certain acts. 1.6148 Elections with respect to separate operating mineral interests for taxable years beginning after December 31, 1963, in the case of oil and gas wells. 1.6151 Pre-1970 exploration expenditures. 1.6152 Deduction of pre-1970 exploration ex-penditures in the year paid or incurred. 1.6153 Election to defer pre-1970 explo-ration expenditures. 1.6154 Limitation of amount deductible. 1.6155 Time for making election with re-spect to returns due on or before May 2, 1960. 1.6156 Election to deduct under section 615. 1.6157 Effect of transfer of mineral prop-erty. 1.6158 Termination of section 615. 1.6159 Notification under Tax Reform Act of 1969. 1.6161 Development expenditures. 1.6162 Election to defer. 1.6163 Time for making election with re-spect to returns due on or before May 2, 1960. 1.6171 Exploration expenditures. 1.6172 Limitation on amount deductible. 1.6173 Recapture of exploration expendi-tures. 1.6174 Treatment of gain from disposition of certain mining property. EXCLUSIONS FROM GROSS INCOME 1.6211 Payments to encourage exploration, development, and mining for defense pur-poses. SALES AND EXCHANGES 1.6311 Election to consider cutting as sale or exchange. 1.6312 Gain or loss upon the disposal of timber under cutting contract. 1.6313 Gain or loss upon the disposal of coal or domestic iron ore with a retained eco-nomic interest. 1.6321 Tax on sale of oil or gas properties. MINERAL PRODUCTION PAYMENTS 1.6361 Treatment of production payments as loans. 1.6362 Production payments retained in leasing transactions. 1.6363 Definitions. 1.6364 Effective dates of section 636. CONTINENTAL SHELF AREAS 1.6381 Continental Shelf areas. 1.6382 Effective date. 1.6391.640 [Reserved] AUTHORITY: 26 U.S.C. 7805, unless otherwise noted. Section 1.501(c)(29)1T also issued under 26 U.S.C. 501(c)(29)(B)(i). Sections 1.5041 and 1.5042 also issued under 26 U.S.C. 504(b). Section1.514(c)2 also issued under 26 U.S.C. 514(c)(9)(E)(iii). Section1.5279 also issued under 26 U.S.C. 527(h)(2)(B)(i). Section1.5855 through 1.5858 also issued under 26 U.S.C. 585(b)(3). Section1.5971 through 1.5977 also issued under 26 U.S.C. 597 and 1502. Section1.5978 also issued under 26 U.S.C. 597. SOURCE: T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, unless otherwise noted. EXEMPT ORGANIZATIONS General Rule 1.501(a)1 Exemption from taxation. (a) In general; proof of exemption. (1) Section 501(a) provides an exemption from income taxes for organizations which are described in section 501 (c) or (d) and section 401(a), unless such orga-nization is a feeder organization (see section 502), or unless it engages in a transaction described in section 503. However, the exemption does not ex-tend to unrelated business taxable income of such an organization (see part III (Section 511 and following), subchapter F, chapter 1 of the Code). (2) An organization, other than an employees trust described in section 401(a), is not exempt from tax merely because it is not organized and oper-ated for profit. In order to establish its exemption, it is necessary that every such organization claiming exemption file an application form as set forth below with the district director for the internal revenue district in which is lo-cated the principal place of business or principal office of the organization. Subject only to the Commissioners in-herent power to revoke rulings because of a change in the law or regulations or for other good cause, an organization that has been determined by the Com-missioner or the district director to be exempt under section 501(a) or the cor-responding provision of prior law may rely upon such determination so long as there are no substantial changes in the organizations character, purposes, VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00019 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15010 26 CFR Ch. I (4113 Edition) 1.501(c)(2)1 or methods of operation. An organiza-tion which has been determined to be exempt under the provisions of the In-ternal Revenue Code of 1939 or prior law is not required to secure a new de-termination of exemption merely be-cause of the enactment of the Internal Revenue Code of 1954 unless affected by substantive changes in law made by such Code. (3) An organization claiming exemp-tion under section 501(a) and described in any paragraph of section 501(c) (other than section 501(c)(1) shall file the form of application prescribed by the Commissioner and shall include thereon such information as required by such form and the instructions issued with respect thereto. For rules relating to the obtaining of a deter-mination of exempt status by an em-ployees trust described in section 401(a), see the regulations under sec-tion 401. (b) Additional proof by particular class-es of organizations. (1) Organizations mentioned below shall submit with and as a part of their applications the fol-lowing information: (i) Mutual insurance companies shall submit copies of the policies or certifi-cates of membership issued by them. (ii) In the case of title holding com-panies described in section 501(c)(2), if the organization for which title is held has not been specifically notified in writing by the Internal Revenue Serv-ice that it is held to be exempt under section 501(a), the title holding com-pany shall submit the information in-dicated herein as necessary for a deter-mination of the status of the organiza-tion for which title is held. (iii) An organization described in sec-tion 501(c)(3) shall submit with, and as a part of, an application filed after July 26, 1959, a detailed statement of its proposed activities. (2) In addition to the information specifically called for by this section, the Commissioner may require any ad-ditional information deemed necessary for a proper determination of whether a particular organization is exempt under section 501(a), and when deemed advisable in the interest of an efficient administration of the internal revenue laws, he may in the cases of particular types of organizations prescribe the form in which the proof of exemption shall be furnished. (3) An organization claiming to be specifically exempted by section 6033(a) from filing annual returns shall submit with and as a part of its application a statement of all the facts on which it bases its claim. (c) Private shareholder or individual de-fined. The words private shareholder or individual in section 501 refer to per-sons having a personal and private in-terest in the activities of the organiza-tion. (d) Requirement of annual returns. For the annual return requirements of or-ganizations exempt under section 501(a), see section 6033 and 1.60331. (e) Certain Puerto Rican pension, etc., trusts. Effective for taxable years be-ginning after December 31, 1973, section 1022(i)(1) of the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 942) provides that trusts under certain Puerto Rican pension, etc., plans (as defined under P.R. Laws Ann. tit. 13, section 3165, and the articles thereunder), all of the participants of which are residents of the Common-wealth of Puerto Rico, are to be treat-ed only for purposes of section 501(a) as trusts described in section 401(a). The practical effect of section 1022(i)(1) is to exempt these trusts from U.S. in-come tax on income from their U.S. in-vestments. For purposes of section 1022(i)(1), the term residents of the Com-monwealth of Puerto Rico means bona fide residents of Puerto Rico, and per-sons who perform labor or services pri-marily within the Commonwealth of Puerto Rico, regardless of residence for other purposes, and the term partici-pants is restricted to current employ-ees who are not excluded under the eli-gibility provisions of the plan. [T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7428, 41 FR 34619, Aug. 16, 1976; T.D. 7859, 47 FR 54298, Dec. 2, 1982] 1.501(c)(2)1 Corporations organized to hold title to property for exempt organizations. (a) A corporation described in section 501(c)(2) and otherwise exempt from tax under section 501(a) is taxable upon its unrelated business taxable income. For taxable years beginning before January VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00020 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15011 Internal Revenue Service, Treasury 1.501(c)(3)1 1, 1970, see 1.5112(c)(4). Since a cor-poration described in section 501(c)(2) cannot be exempt under section 501(a) if it engages in any business other than that of holding title to property and collecting income therefrom, it cannot have unrelated business taxable in-come as defined in section 512 other than income which is treated as unre-lated business taxable income solely because of the applicability of section 512(a)(3)(C); or debt financed income which is treated as unrelated business taxable income solely because of sec-tion 514; or certain interest, annuities, royalties, or rents which are treated as unrelated business taxable income solely because of section 512(b) (3)(B)(ii) or (13). Similarly, exempt sta-tus under section 501(c)(2) shall not be affected where certain rents from per-sonal property leased with real prop-erty are treated as unrelated business taxable income under section 512(b)(3)(A)(ii) solely because such rents attributable to such personal property are more than incidental when compared to the total rents re-ceived or accrued under the lease, or under section 512(b)(3)(B)(i) solely be-cause such rents attributable to such personal property exceed 50 percent of the total rents received or accrued under the lease. (b) A corporation described in section 501(c)(2) cannot accumulate income and retain its exemption, but it must turn over the entire amount of such income, less expenses, to an organization which is itself exempt from tax under section 501(a). [T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7658, 45 FR 33972, May 21, 1980] 1.501(c)(3)1 Organizations organized and operated for religious, chari-table, scientific, testing for public safety, literary, or educational pur-poses, or for the prevention of cru-elty to children or animals. (a) Organizational and operational tests. (1) In order to be exempt as an or-ganization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt. (2) The term exempt purpose or pur-poses, as used in this section, means any purpose or purposes specified in section 501(c)(3), as defined and elabo-rated in paragraph (d) of this section. (b) Organizational test(1) In general. (i) An organization is organized exclu-sively for one or more exempt purposes only if its articles of organization (re-ferred to in this section as its articles) as defined in subparagraph (2) of this paragraph: (A) Limit the purposes of such orga-nization to one or more exempt pur-poses; and (B) Do not expressly empower the or-ganization to engage, otherwise than as an insubstantial part of its activi-ties, in activities which in themselves are not in furtherance of one or more exempt purposes. (ii) In meeting the organizational test, the organizations purposes, as stated in its articles, may be as broad as, or more specific than, the purposes stated in section 501(c)(3). Therefore, an organization which, by the terms of its articles, is formed for literary and scientific purposes within the meaning of section 501(c)(3) of the Code shall, if it otherwise meets the requirements in this paragraph, be considered to have met the organizational test. Similarly, articles stating that the organization is created solely to receive contributions and pay them over to organizations which are described in section 501(c)(3) and ex-empt from taxation under section 501(a)) are sufficient for purposes of the orga-nizational test. Moreover, it is suffi-cient if the articles set for the purpose of the organization to be the operation of a school for adult education and de-scribe in detail the manner of the oper-ation of such school. In addition, if the articles state that the organization is formed for charitable purposes, such ar-ticles ordinarily shall be sufficient for purposes of the organizational test (see subparagraph (5) of this paragraph for rules relating to construction of terms). (iii) An organization is not organized exclusively for one or more exempt purposes if its articles expressly em-power it to carry on, otherwise than as an insubstantial part of its activities, VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00021 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15012 26 CFR Ch. I (4113 Edition) 1.501(c)(3)1 activities which are not in furtherance of one or more exempt purposes, even though such organization is, by the terms of such articles, created for a purpose that is no broader than the purposes specified in section 501(c)(3). Thus, an organization that is empow-ered by its articles to engage in a manu-facturing business, or to engage in the op-eration of a social club does not meet the organizational test regardless of the fact that its articles may state that such organization is created for charitable purposes within the meaning of section 501(c)(3) of the Code. (iv) In no case shall an organization be considered to be organized exclu-sively for one or more exempt pur-poses, if, by the terms of its articles, the purposes for which such organiza-tion is created are broader than the purposes specified in section 501(c)(3). The fact that the actual operations of such an organization have been exclu-sively in furtherance of one or more ex-empt purposes shall not be sufficient to permit the organization to meet the or-ganizational test. Similarly, such an organization will not meet the organi-zational test as a result of statements or other evidence that the members thereof intend to operate only in fur-therance of one or more exempt pur-poses. (v) An organization must, in order to establish its exemption, submit a de-tailed statement of its proposed activi-ties with and as a part of its applica-tion for exemption (see paragraph (b) of 1.501(a)1). (2) Articles of organization. For pur-poses of this section, the term articles of organization or articles includes the trust instrument, the corporate char-ter, the articles of association, or any other written instrument by which an organization is created. (3) Authorization of legislative or polit-ical activities. An organization is not or-ganized exclusively for one or more ex-empt purposes if its articles expressly empower it: (i) To devote more than an insubstan-tial part of its activities to attempting to influence legislation by propaganda or otherwise; or (ii) Directly or indirectly to partici-pate in, or intervene in (including the publishing or distributing of state-ments), any political campaign on be-half of or in opposition to any can-didate for public office; or (iii) To have objectives and to engage in activities which characterize it as an action organization as defined in paragraph (c)(3) of this section. The terms used in subdivisions (i), (ii), and (iii) of this subparagraph shall have the meanings provided in para-graph (c)(3) of this section. An organi-zations articles will not violate the provisions of paragraph (b)(3)(i) of this section even though the organizations articles expressly empower it to make the election provided for in section 501(h) with respect to influencing legis-lation and, only if it so elects, to make lobbying or grass roots expenditures that do not normally exceed the ceiling amounts prescribed by section 501(h)(2) (B) and (D). (4) Distribution of assets on dissolution. An organization is not organized exclu-sively for one or more exempt purposes unless its assets are dedicated to an ex-empt purpose. An organizations assets will be considered dedicated to an ex-empt purpose, for example, if, upon dis-solution, such assets would, by reason of a provision in the organizations ar-ticles or by operation of law, be distrib-uted for one or more exempt purposes, or to the Federal Government, or to a State or local government, for a public purpose, or would be distributed by a court to another organization to be used in such manner as in the judg-ment of the court will best accomplish the general purposes for which the dis-solved organization was organized. However, an organization does not meet the organizational test if its arti-cles or the law of the State in which it was created provide that its assets would, upon dissolution, be distributed to its members or shareholders. (5) Construction of terms. The law of the State in which an organization is created shall be controlling in con-struing the terms of its articles. How-ever, any organization which contends that such terms have under State law a different meaning from their generally accepted meaning must establish such special meaning by clear and con-vincing reference to relevant court de-cisions, opinions of the State attorney- VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00022 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15013 Internal Revenue Service, Treasury 1.501(c)(3)1 general, or other evidence of applicable State law. (6) Applicability of the organizational test. A determination by the Commis-sioner or a district director that an or-ganization is described in section 501(c)(3) and exempt under section 501(a) will not be granted after July 26, 1959 (regardless of when the application is filed), unless such organization meets the organizational test pre-scribed by this paragraph. If, before July 27, 1959, an organization has been determined by the Commissioner or district director to be exempt as an or-ganization described in section 501(c)(3) or in a corresponding provision of prior law and such determination has not been revoked before such date, the fact that such organization does not meet the organizational test prescribed by this paragraph shall not be a basis for revoking such determination. Accord-ingly, an organization which has been determined to be exempt before July 27, 1959, and which does not seek a new determination of exemption is not re-quired to amend its articles of organi-zation to conform to the rules of this paragraph, but any organization which seeks a determination of exemption after July 26, 1959, must have articles of organization which meet the rules of this paragraph. For the rules relating to whether an organization determined to be exempt before July 27, 1959, is or-ganized exclusively for one or more ex-empt purposes, see 26 CFR (1939) 39.101(6)1 (Regulations 118) as made ap-plicable to the Code by Treasury Deci-sion 6091, approved August 16, 1954 (19 FR 5167; C.B. 19542, 47). (c) Operational test(1) Primary activi-ties. An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages pri-marily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organi-zation will not be so regarded if more than an insubstantial part of its activi-ties is not in furtherance of an exempt purpose. (2) Distribution of earnings. An organi-zation is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals. For the definition of the words private shareholder or individual, see paragraph (c) of 1.501(a)1. (3) Action organizations. (i) An organi-zation is not operated exclusively for one or more exempt purposes if it is an action organization as defined in sub-divisions (ii), (iii), or (iv) of this sub-paragraph. (ii) An organization is an action orga-nization if a substantial part of its ac-tivities is attempting to influence leg-islation by propaganda or otherwise. For this purpose, an organization will be regarded as attempting to influence legislation if the organization: (a) Contacts, or urges the public to contact, members of a legislative body for the purpose of proposing, sup-porting, or opposing legislation; or (b) Advocates the adoption or rejec-tion of legislation. The term legislation, as used in this subdivision, includes action by the Congress, by any State legislature, by any local council or similar governing body, or by the public in a referendum, initiative, constitutional amendment, or similar procedure. An organization will not fail to meet the operational test merely because it advocates, as an insubstantial part of its activities, the adoption or rejection of legislation. An organization for which the expenditure test election of section 501(h) is in ef-fect for a taxable year will not be con-sidered an action organization by rea-son of this paragraph (c)(3)(ii) for that year if it is not denied exemption from taxation under section 501(a) by reason of section 501(h). (iii) An organization is an action or-ganization if it participates or inter-venes, directly or indirectly, in any po-litical campaign on behalf of or in op-position to any candidate for public of-fice. The term candidate for public office means an individual who offers him-self, or is proposed by others, as a con-testant for an elective public office, whether such office be national, State, or local. Activities which constitute participation or intervention in a polit-ical campaign on behalf of or in opposi-tion to a candidate include, but are not limited to, the publication or distribu-tion of written or printed statements or the making of oral statements on VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00023 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15014 26 CFR Ch. I (4113 Edition) 1.501(c)(3)1 behalf of or in opposition to such a can-didate. (iv) An organization is an action orga-nization if it has the following two characteristics: (a) Its main or primary objective or objectives (as distin-guished from its incidental or sec-ondary objectives) may be attained only by legislation or a defeat of pro-posed legislation; and (b) it advocates, or campaigns for, the attainment of such main or primary objective or ob-jectives as distinguished from engaging in nonpartisan analysis, study, or re-search and making the results thereof available to the public. In determining whether an organization has such char-acteristics, all the surrounding facts and circumstances, including the arti-cles and all activities of the organiza-tion, are to be considered. (v) An action organization, described in subdivisions (ii) or (iv) of this sub-paragraph, though it cannot qualify under section 501(c)(3), may neverthe-less qualify as a social welfare organi-zation under section 501(c)(4) if it meets the requirements set out in paragraph (a) of 1.501(c)(4)1. (d) Exempt purposes(1) In general. (i) An organization may be exempt as an organization described in section 501(c)(3) if it is organized and operated exclusively for one or more of the fol-lowing purposes: (a) Religious, (b) Charitable, (c) Scientific, (d) Testing for public safety, (e) Literary, (f) Educational, or (g) Prevention of cruelty to children or animals. (ii) An organization is not organized or operated exclusively for one or more of the purposes specified in subdivision (i) of this subparagraph unless it serves a public rather than a private interest. Thus, to meet the requirement of this subdivision, it is necessary for an orga-nization to establish that it is not or-ganized or operated for the benefit of private interests such as designated in-dividuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indi-rectly, by such private interests. (iii) Examples. The following exam-ples illustrate the requirement of para-graph (d)(1)(ii) of this section that an organization serve a public rather than a private interest: Example 1. (i) O is an educational organiza-tion the purpose of which is to study history and immigration. Os educational activities include sponsoring lectures and publishing a journal. The focus of Os historical studies is the genealogy of one family, tracing the de-scent of its present members. O actively so-licits for membership only individuals who are members of that one family. Os research is directed toward publishing a history of that family that will document the pedigrees of family members. A major objective of Os research is to identify and locate living de-scendants of that family to enable those de-scendants to become acquainted with each other. (ii) Os educational activities primarily serve the private interests of members of a single family rather than a public interest. Therefore, O is operated for the benefit of private interests in violation of the restric-tion on private benefit in paragraph (d)(1)(ii) of this section. Based on these facts and cir-cumstances, O is not operated exclusively for exempt purposes and, therefore, is not de-scribed in section 501(c)(3). Example 2. (i) O is an art museum. Os prin-cipal activity is exhibiting art created by a group of unknown but promising local art-ists. Os activity, including organized tours of its art collection, promotes the arts. O is governed by a board of trustees unrelated to the artists whose work O exhibits. All of the art exhibited is offered for sale at prices set by the artist. Each artist whose work is ex-hibited has a consignment arrangement with O. Under this arrangement, when art is sold, the museum retains 10 percent of the selling price to cover the costs of operating the mu-seum and gives the artist 90 percent. (ii) The artists in this situation directly benefit from the exhibition and sale of their art. As a result, the principal activity of O serves the private interests of these artists. Because O gives 90 percent of the proceeds from its sole activity to the individual art-ists, the direct benefits to the artists are substantial and Os provision of these bene-fits to the artists is more than incidental to its other purposes and activities. This ar-rangement causes O to be operated for the benefit of private interests in violation of the restriction on private benefit in para-graph (d)(1)(ii) of this section. Based on these facts and circumstances, O is not operated exclusively for exempt purposes and, there-fore, is not described in section 501(c)(3). Example 3. (i) O is an educational organiza-tion the purpose of which is to train individ-uals in a program developed by P, Os presi-dent. The program is of interest to aca-demics and professionals, representatives of whom serve on an advisory panel to O. All of VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00024 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15015 Internal Revenue Service, Treasury 1.501(c)(3)1 the rights to the program are owned by Com-pany K, a for-profit corporation owned by P. Prior to the existence of O, the teaching of the program was conducted by Company K. O licenses, from Company K, the right to con-duct seminars and lectures on the program and to use the name of the program as part of Os name, in exchange for specified roy-alty payments. Under the license agreement, Company K provides O with the services of trainers and with course materials on the program. O may develop and copyright new course materials on the program but all such materials must be assigned to Company K without consideration if and when the li-cense agreement is terminated. Company K sets the tuition for the seminars and lectures on the program conducted by O. O has agreed not to become involved in any activity re-sembling the program or its implementation for 2 years after the termination of Os li-cense agreement. (ii) Os sole activity is conducting seminars and lectures on the program. This arrange-ment causes O to be operated for the benefit of P and Company K in violation of the re-striction on private benefit in paragraph (d)(1)(ii) of this section, regardless of wheth-er the royalty payments from O to Company K for the right to teach the program are rea-sonable. Based on these facts and cir-cumstances, O is not operated exclusively for exempt purposes and, therefore, is not de-scribed in section 501(c)(3). (iv) Since each of the purposes speci-fied in subdivision (i) of this subpara-graph is an exempt purpose in itself, an organization may be exempt if it is or-ganized and operated exclusively for any one or more of such purposes. If, in fact, an organization is organized and operated exclusively for an exempt purpose or purposes, exemption will be granted to such an organization re-gardless of the purpose or purposes specified in its application for exemp-tion. For example, if an organization claims exemption on the ground that it is educational, exemption will not be denied if, in fact, it is charitable. (2) Charitable defined. The term chari-table is used in section 501(c)(3) in its generally accepted legal sense and is, therefore, not to be construed as lim-ited by the separate enumeration in section 501(c)(3) of other tax-exempt purposes which may fall within the broad outlines of charity as developed by judicial decisions. Such term in-cludes: Relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of Govern-ment; and promotion of social welfare by organizations designed to accom-plish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimina-tion; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency. The fact that an organiza-tion which is organized and operated for the relief of indigent persons may receive voluntary contributions from the persons intended to be relieved will not necessarily prevent such organiza-tion from being exempt as an organiza-tion organized and operated exclu-sively for charitable purposes. The fact that an organization, in carrying out its primary purpose, advocates social or civic changes or presents opinion on controversial issues with the intention of molding public opinion or creating public sentiment to an acceptance of its views does not preclude such orga-nization from qualifying under section 501(c)(3) so long as it is not an action organization of any one of the types de-scribed in paragraph (c)(3) of this sec-tion. (3) Educational defined(i) In general. The term educational, as used in sec-tion 501(c)(3), relates to: (a) The instruction or training of the individual for the purpose of improving or developing his capabilities; or (b) The instruction of the public on subjects useful to the individual and beneficial to the community. An organization may be educational even though it advocates a particular position or viewpoint so long as it pre-sents a sufficiently full and fair expo-sition of the pertinent facts as to per-mit an individual or the public to form an independent opinion or conclusion. On the other hand, an organization is not educational if its principal func-tion is the mere presentation of unsup-ported opinion. (ii) Examples of educational organiza-tions. The following are examples of or-ganizations which, if they otherwise meet the requirements of this section, are educational: Example 1. An organization, such as a pri-mary or secondary school, a college, or a VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00025 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15016 26 CFR Ch. I (4113 Edition) 1.501(c)(3)1 professional or trade school, which has a reg-ularly scheduled curriculum, a regular fac-ulty, and a regularly enrolled body of stu-dents in attendance at a place where the edu-cational activities are regularly carried on. Example 2. An organization whose activi-ties consist of presenting public discussion groups, forums, panels, lectures, or other similar programs. Such programs may be on radio or television. Example 3. An organization which presents a course of instruction by means of cor-respondence or through the utilization of tel-evision or radio. Example 4. useums, zoos, planetariums, symphony orchestras, and other similar or-ganizations. (4) Testing for public safety defined. The term testing for public safety, as used in section 501(c)(3), includes the testing of consumer products, such as electrical products, to determine whether they are safe for use by the general public. (5) Scientific defined. (i) Since an orga-nization may meet the requirements of section 501(c)(3) only if it serves a pub-lic rather than a private interest, a sci-entific organization must be organized and operated in the public interest (see subparagraph (1)(ii) of this paragraph). Therefore, the term scientific, as used in section 501(c)(3), includes the car-rying on of scientific research in the public interest. Research when taken alone is a word with various meanings; it is not synonymous with scientific; and the nature of particular research depends upon the purpose which it serves. For research to be scientific, within the meaning of section 501(c)(3), it must be carried on in furtherance of a scientific purpose. The determination as to whether research is scientific does not depend on whether such research is classified as fundamental or basic as contrasted with applied or practical. On the other hand, for purposes of the ex-clusion from unrelated business tax-able income provided by section 512(b)(9), it is necessary to determine whether the organization is operated primarily for purposes of carrying on fundamental, as contrasted with ap-plied, research. (ii) Scientific research does not in-clude activities of a type ordinarily carried on as an incident to commer-cial or industrial operations, as, for ex-ample, the ordinary testing or inspec-tion of materials or products or the de-signing or construction of equipment, buildings, etc. (iii) Scientific research will be re-garded as carried on in the public in-terest: (a) If the results of such research (in-cluding any patents, copyrights, proc-esses, or formulae resulting from such research) are made available to the public on a nondiscriminatory basis; (b) If such research is performed for the United States, or any of its agen-cies or instrumentalities, or for a State or political subdivision thereof; or (c) If such research is directed toward benefiting the public. The following are examples of scientific research which will be considered as directed toward benefiting the public, and, therefore, which will be regarded as carried on in the public interest: (1) Scientific re-search carried on for the purpose of aiding in the scientific education of college or university students; (2) sci-entific research carried on for the pur-pose of obtaining scientific informa-tion, which is published in a treatise, thesis, trade publication, or in any other form that is available to the in-terested public; (3) scientific research carried on for the purpose of discov-ering a cure for a disease; or (4) sci-entific research carried on for the pur-pose of aiding a community or geo-graphical area by attracting new indus-try to the community or area or by en-couraging the development of, or reten-tion of, an industry in the community or area. Scientific research described in this subdivision will be regarded as carried on in the public interest even though such research is performed pur-suant to a contract or agreement under which the sponsor or sponsors of the re-search have the right to obtain owner-ship or control of any patents, copy-rights, processes, or formulae resulting from such research. (iv) An organization will not be re-garded as organized and operated for the purpose of carrying on scientific re-search in the public interest and, con-sequently, will not qualify under sec-tion 501(c)(3) as a scientific organiza-tion, if: (a) Such organization will perform research only for persons which are (di-rectly or indirectly) its creators and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00026 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15017 Internal Revenue Service, Treasury 1.501(c)(3)1 which are not described in section 501(c)(3), or (b) Such organization retains (di-rectly or indirectly) the ownership or control of more than an insubstantial portion of the patents, copyrights, processes, or formulae resulting from its research and does not make such patents, copyrights, processes, or for-mulae available to the public. For pur-poses of this subdivision, a patent, copyright, process, or formula shall be considered as made available to the public if such patent, copyright, proc-ess, or formula is made available to the public on a nondiscriminatory basis. In addition, although one person is grant-ed the exclusive right to the use of a patent, copyright, process, or formula, such patent, copyright, process, or for-mula shall be considered as made avail-able to the public if the granting of such exclusive right is the only prac-ticable manner in which the patent, copyright, process, or formula can be utilized to benefit the public. In such a case, however, the research from which the patent, copyright, process, or for-mula resulted will be regarded as car-ried on in the public interest (within the meaning of subdivision (iii) of this subparagraph) only if it is carried on for a person described in subdivision (iii)(b) of this subparagraph or if it is scientific research described in subdivi-sion (iii)(c) of this subparagraph. (v) The fact that any organization (including a college, university, or hos-pital) carries on research which is not in furtherance of an exempt purpose described in section 501(c)(3) will not preclude such organization from meet-ing the requirements of section 501(c)(3) so long as the organization meets the organizational test and is not operated for the primary purpose of carrying on such research (see para-graph (e) of this section, relating to or-ganizations carrying on a trade or busi-ness). See paragraph (a)(5) of 1.5132, with respect to research which con-stitutes an unrelated trade or business, and section 512(b) (7), (8), and (9), with respect to income derived from re-search which is excludable from the tax on unrelated business income. (vi) The regulations in this subpara-graph are applicable with respect to taxable years beginning after Decem-ber 31, 1960. (e) Organizations carrying on trade or business(1) In general. An organization may meet the requirements of section 501(c)(3) although it operates a trade or business as a substantial part of its ac-tivities, if the operation of such trade or business is in furtherance of the or-ganizations exempt purpose or pur-poses and if the organization is not or-ganized or operated for the primary purpose of carrying on an unrelated trade or business, as defined in section 513. In determining the existence or nonexistence of such primary purpose, all the circumstances must be consid-ered, including the size and extent of the trade or business and the size and extent of the activities which are in furtherance of one or more exempt pur-poses. An organization which is orga-nized and operated for the primary pur-pose of carrying on an unrelated trade or business is not exempt under section 501(c)(3) even though it has certain reli-gious purposes, its property is held in common, and its profits do not inure to the benefit of individual members of the organization. See, however, section 501(d) and 1.501(d)1, relating to reli-gious and apostolic organizations. (2) Taxation of unrelated business in-come. For provisions relating to the taxation of unrelated business income of certain organizations described in section 501(c)(3), see sections 511 to 515, inclusive, and the regulations there-under. (f) Interaction with section 4958(1) Application process. An organization that applies for recognition of exemp-tion under section 501(a) as an organi-zation described in section 501(c)(3) must establish its eligibility under this section. The Commissioner may deny an application for exemption for fail-ure to establish any of section 501(c)(3)s requirements for exemption. Section 4958 does not apply to trans-actions with an organization that has failed to establish that it satisfies all of the requirements for exemption under section 501(c)(3). See 53.49582. (2) Substantive requirements for exemp-tion still apply to applicable tax-exempt organizations described in section 501(c)(3)(i) In general. Regardless of whether a particular transaction is VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00027 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15018 26 CFR Ch. I (4113 Edition) 1.501(c)(3)1 subject to excise taxes under section 4958, the substantive requirements for tax exemption under section 501(c)(3) still apply to an applicable tax-exempt organization (as defined in section 4958(e) and 53.49582) described in sec-tion 501(c)(3) whose disqualified persons or organization managers are subject to excise taxes under section 4958. Ac-cordingly, an organization will no longer meet the requirements for tax- exempt status under section 501(c)(3) if the organization fails to satisfy the re-quirements of paragraph (b), (c) or (d) of this section. See 53.49588(a). (ii) Determination of whether revoca-tion of tax-exempt status is appropriate when section 4958 excise taxes also apply. In determining whether to continue to recognize the tax-exempt status of an applicable tax-exempt organization (as defined in section 4958(e) and 53.49582) described in section 501(c)(3) that en-gages in one or more excess benefit transactions (as defined in section 4958(c) and 53.49584) that violate the prohibition on inurement under section 501(c)(3), the Commissioner will con-sider all relevant facts and cir-cumstances, including, but not limited to, the following (A) The size and scope of the organi-zations regular and ongoing activities that further exempt purposes before and after the excess benefit transaction or transactions occurred; (B) The size and scope of the excess benefit transaction or transactions (collectively, if more than one) in rela-tion to the size and scope of the organi-zations regular and ongoing activities that further exempt purposes; (C) Whether the organization has been involved in multiple excess ben-efit transactions with one or more per-sons; (D) Whether the organization has im-plemented safeguards that are reason-ably calculated to prevent excess ben-efit transactions; and (E) Whether the excess benefit trans-action has been corrected (within the meaning of section 4958(f)(6) and 53.49587), or the organization has made good faith efforts to seek correc-tion from the disqualified person(s) who benefited from the excess benefit transaction. (iii) All factors will be considered in combination with each other. Depend-ing on the particular situation, the Commissioner may assign greater or lesser weight to some factors than to others. The factors listed in paragraphs (f)(2)(ii)(D) and (E) of this section will weigh more heavily in favor of con-tinuing to recognize exemption where the organization discovers the excess benefit transaction or transactions and takes action before the Commissioner discovers the excess benefit trans-action or transactions. Further, with respect to the factor listed in para-graph (f)(2)(ii)(E) of this section, cor-rection after the excess benefit trans-action or transactions are discovered by the Commissioner, by itself, is never a sufficient basis for continuing to rec-ognize exemption. (iv) Examples. The following examples illustrate the principles of paragraph (f)(2)(ii) of this section. For purposes of each example, assume that O is an ap-plicable tax-exempt organization (as defined in section 4958(e) and 53.49582) described in section 501(c)(3). The ex-amples read as follows: Example 1. (i) O was created as a museum for the purpose of exhibiting art to the gen-eral public. In Years 1 and 2, O engages in fundraising and in selecting, leasing, and preparing an appropriate facility for a mu-seum. In Year 3, a new board of trustees is elected. All of the new trustees are local art dealers. Beginning in Year 3 and continuing to the present, O uses a substantial portion of its revenues to purchase art solely from its trustees at prices that exceed fair market value. O exhibits and offers for sale all of the art it purchases. Os Form 1023, Application for Recognition of Exemption, did not dis-close the possibility that O would purchase art from its trustees. (ii) Os purchases of art from its trustees at more than fair market value constitute ex-cess benefit transactions between an applica-ble tax-exempt organization and disqualified persons under section 4958. Therefore, these transactions are subject to the applicable ex-cise taxes provided in that section. In addi-tion, Os purchases of art from its trustees at more than fair market value violate the pro-scription against inurement under section 501(c)(3) and paragraph (c)(2) of this section. (iii) The application of the factors in para-graph (f)(2)(ii) of this section to these facts is as follows. Beginning in Year 3, O does not engage primarily in regular and ongoing ac-tivities that further exempt purposes be-cause a substantial portion of Os activities VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00028 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15019 Internal Revenue Service, Treasury 1.501(c)(3)1 consists of purchasing art from its trustees and dealing in such art in a manner similar to a commercial art gallery. The size and scope of the excess benefit transactions col-lectively are significant in relation to the size and scope of any of Os ongoing activi-ties that further exempt purposes. O has been involved in multiple excess benefit transactions, namely, purchases of art from its trustees at more than fair market value. O has not implemented safeguards that are reasonably calculated to prevent such im-proper purchases in the future. The excess benefit transactions have not been corrected, nor has O made good faith efforts to seek correction from the disqualified persons who benefited from the excess benefit trans-actions (the trustees). The trustees continue to control Os Board. Based on the applica-tion of the factors to these facts, O is no longer described in section 501(c)(3) effective in Year 3. Example 2. (i) The facts are the same as in Example 1, except that in Year 4, Os entire board of trustees resigns, and O no longer of-fers all exhibited art for sale. The former board is replaced with members of the com-munity who are not in the business of buying or selling art and who have skills and experi-ence running charitable and educational pro-grams and institutions. O promptly discon-tinues the practice of purchasing art from current or former trustees, adopts a written conflicts of interest policy, adopts written art valuation guidelines, hires legal counsel to recover the excess amounts O had paid its former trustees, and implements a new pro-gram of activities to further the publics ap-preciation of the arts. (ii) Os purchases of art from its former trustees at more than fair market value con-stitute excess benefit transactions between an applicable tax-exempt organization and disqualified persons under section 4958. Therefore, these transactions are subject to the applicable excise taxes provided in that section. In addition, Os purchases of art from its trustees at more than fair market value violate the proscription against inurement under section 501(c)(3) and para-graph (c)(2) of this section. (iii) The application of the factors in para-graph (f)(2)(ii) of this section to these facts is as follows. In Year 3, O does not engage pri-marily in regular and ongoing activities that further exempt purposes. However, in Year 4, O elects a new board of trustees comprised of individuals who have skills and experience running charitable and educational programs and implements a new program of activities to further the publics appreciation of the arts. As a result of these actions, beginning in Year 4, O engages in regular and ongoing activities that further exempt purposes. The size and scope of the excess benefit trans-actions that occurred in Year 3, taken collec-tively, are significant in relation to the size and scope of Os regular and ongoing exempt function activities that were conducted in Year 3. Beginning in Year 4, however, as Os exempt function activities grow, the size and scope of the excess benefit transactions that occurred in Year 3 become less and less sig-nificant as compared to the size and scope of Os regular and ongoing exempt function ac-tivities. O was involved in multiple excess benefit transactions in Year 3. However, by discontinuing its practice of purchasing art from its current and former trustees, by re-placing its former board with independent members of the community, and by adopting a conflicts of interest policy and art valu-ation guidelines, O has implemented safe-guards that are reasonably calculated to pre-vent future violations. In addition, O has made a good faith effort to seek correction from the disqualified persons who benefited from the excess benefit transactions (its former trustees). Based on the application of the factors to these facts, O continues to meet the requirements for tax exemption under section 501(c)(3). Example 3. (i) O conducts educational pro-grams for the benefit of the general public. Since its formation, O has employed its founder, C, as its Chief Executive Officer. Be-ginning in Year 5 of Os operations and con-tinuing to the present, C caused O to divert significant portions of Os funds to pay Cs personal expenses. The diversions by C sig-nificantly reduced the funds available to conduct Os ongoing educational programs. The board of trustees never authorized C to cause O to pay Cs personal expenses from Os funds. Certain members of the board were aware that O was paying Cs personal ex-penses. However, the board did not terminate Cs employment and did not take any action to seek repayment from C or to prevent C from continuing to divert Os funds to pay Cs personal expenses. C claimed that Os payments of Cs personal expenses rep-resented loans from O to C. However, no con-temporaneous loan documentation exists, and C never made any payments of principal or interest. (ii) The diversions of Os funds to pay Cs personal expenses constitute excess benefit transactions between an applicable tax-ex-empt organization and a disqualified person under section 4958. Therefore, these trans-actions are subject to the applicable excise taxes provided in that section. In addition, these transactions violate the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section. (iii) The application of the factors in para-graph (f)(2)(ii) of this section to these facts is as follows. O has engaged in regular and on-going activities that further exempt pur-poses both before and after the excess benefit transactions occurred. However, the size and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00029 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15020 26 CFR Ch. I (4113 Edition) 1.501(c)(3)1 scope of the excess benefit transactions en-gaged in by O beginning in Year 5, collec-tively, are significant in relation to the size and scope of Os activities that further ex-empt purposes. Moreover, O has been in-volved in multiple excess benefit trans-actions. O has not implemented any safe-guards that are reasonably calculated to pre-vent future diversions. The excess benefit transactions have not been corrected, nor has O made good faith efforts to seek correc-tion from C, the disqualified person who ben-efited from the excess benefit transactions. Based on the application of the factors to these facts, O is no longer described in sec-tion 501(c)(3) effective in Year 5. Example 4. (i) O conducts activities that further exempt purposes. O uses several buildings in the conduct of its exempt activi-ties. In Year 1, O sold one of the buildings to Company K for an amount that was substan-tially below fair market value. The sale was a significant event in relation to Os other activities. C, Os Chief Executive Officer, owns all of the voting stock of Company K. When Os board of trustees approved the transaction with Company K, the board did not perform due diligence that could have made it aware that the price paid by Com-pany K to acquire the building was below fair market value. Subsequently, but before the IRS commences an examination of O, Os board of trustees determines that Company K paid less than the fair market value for the building. Thus, O concludes that an ex-cess benefit transaction occurred. After the board makes this determination, it promptly removes C as Chief Executive Officer, termi-nates Cs employment with O, and hires legal counsel to recover the excess benefit from Company K. In addition, O promptly adopts a conflicts of interest policy and new con-tract review procedures designed to prevent future recurrences of this problem. (ii) The sale of the building by O to Com-pany K at less than fair market value con-stitutes an excess benefit transaction be-tween an applicable tax-exempt organization and a disqualified person under section 4958 in Year 1. Therefore, this transaction is sub-ject to the applicable excise taxes provided in that section. In addition, this transaction violates the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section. (iii) The application of the factors in para-graph (f)(2)(ii) of this section to these facts is as follows. O has engaged in regular and on-going activities that further exempt pur-poses both before and after the excess benefit transaction occurred. Although the size and scope of the excess benefit transaction were significant in relation to the size and scope of Os activities that further exempt pur-poses, the transaction with Company K was a one-time occurrence. By adopting a con-flicts of interest policy and new contract re-view procedures and by terminating C, O has implemented safeguards that are reasonably calculated to prevent future violations. Moreover, O took corrective actions before the IRS commenced an examination of O. In addition, O has made a good faith effort to seek correction from Company K, the dis-qualified person who benefited from the ex-cess benefit transaction. Based on the appli-cation of the factors to these facts, O con-tinues to be described in section 501(c)(3). Example 5. (i) O is a large organization with substantial assets and revenues. O conducts activities that further its exempt purposes. O employs C as its Chief Financial Officer. During Year 1, O pays $2,500 of Cs personal expenses. O does not make these payments pursuant to an accountable plan, as de-scribed in 53.49584(a)(4)(ii). In addition, O does not report any of these payments on Cs Form W2, Wage and Tax Statement, or on a Form 1099MISC, Miscellaneous Income, for C for Year 1, and O does not report these payments as compensation on its Form 990, Return of Organization Exempt From In-come Tax, for Year 1. Moreover, none of these payments can be disregarded as non-taxable fringe benefits under 53.49584(c)(2) and none consisted of fixed payments under an initial contract under 53.49584(a)(3). C does not report the $2,500 of payments as in-come on his individual Federal income tax return for Year 1. O does not repeat this re-porting omission in subsequent years and, instead, reports all payments of Cs personal expenses not made under an accountable plan as income to C. (ii) Os payment in Year 1 of $2,500 of Cs personal expenses constitutes an excess ben-efit transaction between an applicable tax- exempt organization and a disqualified per-son under section 4958. Therefore, this trans-action is subject to the applicable excise taxes provided in that section. In addition, this transaction violates the proscription against inurement in section 501(c)(3) and paragraph (c)(2) of this section. (iii) The application of the factors in para-graph (f)(2)(ii) of this section to these facts is as follows. O engages in regular and ongoing activities that further exempt purposes. The payment of $2,500 of Cs personal expenses represented only a de minimis portion of Os assets and revenues; thus, the size and scope of the excess benefit transaction were not significant in relation to the size and scope of Os activities that further exempt pur-poses. The reporting omission that resulted in the excess benefit transaction in Year 1 occurred only once and is not repeated in subsequent years. Based on the application of the factors to these facts, O continues to be described in section 501(c)(3). Example 6. (i) O is a large organization with substantial assets and revenues. O furthers VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00030 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15021 Internal Revenue Service, Treasury 1.501(c)(3)1 its exempt purposes by providing social serv-ices to the population of a specific geo-graphic area. O has a sizeable workforce of employees and volunteers to conduct its work. In Year 1, Os board of directors adopt-ed written procedures for setting executive compensation at O. Os executive compensa-tion procedures were modeled on the proce-dures for establishing a rebuttable presump-tion of reasonableness under 53.49586. In accordance with these procedures, the board appointed a compensation committee to gather data on compensation levels paid by similarly situated organizations for func-tionally comparable positions. The members of the compensation committee were disin-terested within the meaning of 53.4958 6(c)(1)(iii). Based on its research, the com-pensation committee recommended a range of reasonable compensation for several of Os existing top executives (the Top Executives). On the basis of the committees rec-ommendations, the board approved new com-pensation packages for the Top Executives and timely documented the basis for its deci-sion in board minutes. The board members were all disinterested within the meaning of 53.49586(c)(1)(iii). The Top Executives were not involved in setting their own compensa-tion. In Year 1, even though payroll expenses represented a significant portion of Os total operating expenses, the total compensation paid to Os Top Executives represented only an insubstantial portion of Os total payroll expenses. During a subsequent examination, the IRS found that the compensation com-mittee relied exclusively on compensation data from organizations that perform similar social services to O. The IRS concluded, how-ever, that the organizations were not simi-larly situated because they served substan-tially larger geographic regions with more diverse populations and were larger than O in terms of annual revenues, total operating budget, number of employees, and number of beneficiaries served. Accordingly, the IRS concluded that the compensation committee did not rely on appropriate data as to com-parability within the meaning of 53.4958 6(c)(2) and, thus, failed to establish the re-buttable presumption of reasonableness under 53.49586. Taking Os size and the na-ture of the geographic area and population it serves into account, the IRS concluded that the Top Executives compensation packages for Year 1 were excessive. As a result of the examination, Os board added new members to the compensation committee who have expertise in compensation matters and also amended its written procedures to require the compensation committee to evaluate a number of specific factors, including size, ge-ographic area, and population covered by the organization, in assessing the comparability of compensation data. Os board renegotiated the Top Executives contracts in accordance with the recommendations of the newly con-stituted compensation committee on a going forward basis. To avoid potential liability for damages under state contract law, O did not seek to void the Top Executives employ-ment contracts retroactively to Year 1 and did not seek correction of the excess benefit amounts from the Top Executives. O did not terminate any of the Top Executives. (ii) Os payments of excessive compensa-tion to the Top Executives in Year 1 con-stituted excess benefit transactions between an applicable tax-exempt organization and disqualified persons under section 4958. Therefore, these payments are subject to the applicable excise taxes provided under that section, including second-tier taxes if there is no correction by the disqualified persons. In addition, these payments violate the pro-scription against inurement under section 501(c)(3) and paragraph (c)(2) of this section. (iii) The application of the factors in para-graph (f)(2)(ii) of this section to these facts is as follows. O has engaged in regular and on-going activities that further exempt pur-poses both before and after the excess benefit transactions occurred. The size and scope of the excess benefit transactions, in the aggre-gate, were not significant in relation to the size and scope of Os activities that further exempt purposes. O engaged in multiple ex-cess benefit transactions. Nevertheless, prior to entering into these excess benefit trans-actions, O had implemented written proce-dures for setting the compensation of its top management that were reasonably cal-culated to prevent the occurrence of excess benefit transactions. O followed these writ-ten procedures in setting the compensation of the Top Executives for Year 1. Despite the boards failure to rely on appropriate com-parability data, the fact that O implemented and followed these written procedures in set-ting the compensation of the Top Executives for Year 1 is a factor favoring continued ex-emption. The fact that O amended its writ-ten procedures to ensure the use of appro-priate comparability data and renegotiated the Top Executives compensation packages on a going-forward basis are also factors fa-voring continued exemption, even though O did not void the Top Executives existing contracts and did not seek correction from the Top Executives. Based on the application of the factors to these facts, O continues to be described in section 501(c)(3). (3) Applicability. The rules in para-graph (f) of this section will apply with respect to excess benefit transactions occurring after March 28, 2008. (g) Applicability of regulations in this section. The regulations in this section are, except as otherwise expressly pro-vided, applicable with respect to tax-able years beginning after July 26, 1959. For the rules applicable with respect to VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00031 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15022 26 CFR Ch. I (4113 Edition) 1.501(c)(4)1 taxable years beginning before July 27, 1959, see 26 CFR (1939) 39.101(6)1 (Regu-lations 118) as made applicable to the Code by Treasury Decision 6091, ap-proved August 16, 1954 (19 FR 5167; C.B. 19542, 47). [T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6525, 26 FR 189, Jan. 11, 1961; T.D. 6939, 32 FR 17661, Dec. 12, 1967; T.D. 7428, 41 FR 34620, Aug. 16, 1976; T.D. 8308, 55 FR 35587, Aug. 31, 1990; T.D. 9390, 73 FR 16521, Mar. 28, 2008; T.D. 9390, 73 FR 23069, Apr. 29, 2008] 1.501(c)(4)1 Civic organizations and local associations of employees. (a) Civic organizations(1) In general. A civic league or organization may be exempt as an organization described in section 501(c)(4) if (i) It is not organized or operated for profit; and (ii) It is operated exclusively for the promotion of social welfare. (2) Promotion of social welfare(i) In general. An organization is operated ex-clusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. An organization em-braced within this section is one which is operated primarily for the purpose of bringing about civic betterments and social improvements. A social welfare organization will qualify for exemption as a charitable organization if it falls within the definition of charitable set forth in paragraph (d)(2) of 1.501(c)(3) 1 and is not an action organization as set forth in paragraph (c)(3) of 1.501(c)(3)1. (ii) Political or social activities. The promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office. Nor is an organization operated primarily for the promotion of social welfare if its pri-mary activity is operating a social club for the benefit, pleasure, or recreation of its members, or is carrying on a business with the general public in a manner similar to organizations which are operated for profit. See, however, section 501(c)(6) and 1.501(c)(6)1, re-lating to business leagues and similar organizations. A social welfare organi-zation that is not, at any time after October 4, 1976, exempt from taxation as an organization described in section 501(c)(3) may qualify under section 501(c)(4) even though it is an action or-ganization described in 1.501(c)(3) 1(c)(3)(ii) or (iv), if it otherwise quali-fies under this section. For rules relat-ing to an organization that is, after Oc-tober 4, 1976, exempt from taxation as an organization described in section 501(c)(3), see section 504 and 1.5041. (b) Local associations of employees. Local associations of employees de-scribed in section 501(c)(4) are ex-pressly entitled to exemption under section 501(a). As conditions to exemp-tion, it is required (1) that the member-ship of such an association be limited to the employees of a designated per-son or persons in a particular munici-pality, and (2) that the net earnings of the association be devoted exclusively to charitable, educational, or rec-reational purposes. The word local is defined in paragraph (b) of 1.501(c)(12) 1. See paragraph (d) (2) and (3) of 1.501(c)(3)1 with reference to the meaning of charitable and educational as used in this section. [T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as amended by T.D. 8308, 55 FR 35588, Aug. 31, 1990] 1.501(c)(5)1 Labor, agricultural, and horticultural organizations. (a) The organizations contemplated by section 501(c)(5) as entitled to ex-emption from income taxation are those which: (1) Have no net earnings inuring to the benefit of any member, and (2) Have as their objects the better-ment of the conditions of those en-gaged in such pursuits, the improve-ment of the grade of their products, and the development of a higher degree of efficiency in their respective occupa-tions. (b)(1) General rule. An organization is not an organization described in sec-tion 501(c)(5) if the principal activity of the organization is to receive, hold, in-vest, disburse or otherwise manage funds associated with savings or in-vestment plans or programs, including pension or other retirement savings plans or programs. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00032 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15023 Internal Revenue Service, Treasury 1.501(c)(7)1 (2) Exception. Paragraph (b)(1) of this section shall not apply to an organiza-tion which (i) Is established and maintained by another labor organization described in section 501(c)(5) (determined without regard to this paragraph (b)(2)); (ii) Is not directly or indirectly es-tablished or maintained in whole or in part by one or more (A) Employers; (B) Governments or agencies or in-strumentalities thereof; or (C) Government controlled entities; (iii) Is funded by membership dues from members of the labor organiza-tion described in this paragraph (b)(2) and earnings thereon; and (iv) Has not at any time after Sep-tember 2, 1974 (the date of enactment of the Employee Retirement Income Se-curity Act of 1974, Pub. L. 93406, 88 Stat. 829) provided for, permitted or ac-cepted employer contributions. (3) Example. The principles of this paragraph (b) are illustrated by the fol-lowing example: Example. Trust A is organized in accord-ance with a collective bargaining agreement between labor union K and multiple employ-ers. Trust A forms part of a plan that is es-tablished and maintained pursuant to the agreement and which covers employees of the signatory employers who are members of K. Representatives of both the employers and K serve as trustees. A receives contribu-tions from the employers who are subject to the agreement. Retirement benefits paid to Ks members as specified in the agreement are funded exclusively by the employers contributions and accumulated earnings. A also provides information to union members about their retirement benefits and assists them with administrative tasks associated with the benefits. Most of As activities are devoted to these functions. From time to time, A also participates in the renegoti-ation of the collective bargaining agreement. As principal activity is to receive, hold, in-vest, disburse, or otherwise manage funds as-sociated with a retirement savings plan. In addition, A does not satisfy all the require-ments of the exception described in para-graph (b)(2) of this section. (For example, A accepts contributions from employers.) Therefore, A is not a labor organization de-scribed in section 501(c)(5). (c) Organizations described in section 501(c)(5) and otherwise exempt from tax under section 501(a) are taxable upon their unrelated business taxable in-come. See part II (section 511 and fol-lowing), subchapter F, chapter 1 of the Code, and the regulations thereunder. [T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as amended by T.D. 8726, 62 FR 40449, July 29, 1997] 1.501(c)(6)1 Business leagues, cham-bers of commerce, real estate boards, and boards of trade. A business league is an association of persons having some common business interest, the purpose of which is to pro-mote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. It is an organization of the same general class as a chamber of commerce or board of trade. Thus, its activities should be di-rected to the improvement of business conditions of one or more lines of busi-ness as distinguished from the perform-ance of particular services for indi-vidual persons. An organization whose purpose is to engage in a regular busi-ness of a kind ordinarily carried on for profit, even though the business is con-ducted on a cooperative basis or pro-duces only sufficient income to be self- sustaining, is not a business league. An association engaged in furnishing in-formation to prospective investors, to enable them to make sound invest-ments, is not a business league, since its activities do not further any com-mon business interest, even though all of its income is devoted to the purpose stated. A stock or commodity exchange is not a business league, a chamber of commerce, or a board of trade within the meaning of section 501(c)(6) and is not exempt from tax. Organizations otherwise exempt from tax under this section are taxable upon their unre-lated business taxable income. See part II (section 511 and following), sub-chapter F, chapter 1 of the Code, and the regulations thereunder. 1.501(c)(7)1 Social clubs. (a) The exemption provided by sec-tion 501(a) for organizations described in section 501(c)(7) applies only to clubs which are organized and operated ex-clusively for pleasure, recreation, and other nonprofitable purposes, but does not apply to any club if any part of its net earnings inures to the benefit of any private shareholder. In general, this exemption extends to social and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00033 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15024 26 CFR Ch. I (4113 Edition) 1.501(c)(8)1 recreation clubs which are supported solely by membership fees, dues, and assessments. However, a club otherwise entitled to exemption will not be dis-qualified because it raises revenue from members through the use of club facilities or in connection with club ac-tivities. (b) A club which engages in business, such as making its social and rec-reational facilities available to the general public or by selling real estate, timber, or other products, is not orga-nized and operated exclusively for pleasure, recreation, and other non-profitable purposes, and is not exempt under section 501(a). Solicitation by ad-vertisement or otherwise for public pa-tronage of its facilities is prima facie evidence that the club is engaging in business and is not being operated ex-clusively for pleasure, recreation, or social purposes. However, an incidental sale of property will not deprive a club of its exemption. 1.501(c)(8)1 Fraternal beneficiary societies. (a) A fraternal beneficiary society is exempt from tax only if operated under the lodge system or for the exclusive benefit of the members so operating. Operating under the lodge system means carrying on its activities under a form of organization that comprises local branches, chartered by a parent organi-zation and largely self-governing, called lodges, chapters, or the like. In order to be exempt it is also necessary that the society have an established system for the payment to its members or their dependents of life, sick, acci-dent, or other benefits. [T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7061, 35 FR 14770, Sept. 23, 1970] 1.501(c)(9)1 Voluntary employees beneficiary associations, in general. To be described in section 501(c)(9) an organization must meet all of the fol-lowing requirements: (a) The organization is an employees association, (b) Membership in the association is voluntary, (c) The organization provides for the payment of life, sick, accident, or other benefits to its members or their dependents or designated beneficiaries, and substantially all of its operations are in furtherance of providing such benefits, and (d) No part of the net earnings of the organization inures, other than by pay-ment of the benefits referred to in paragraph (c) of this section, to the benefit of any private shareholder or individual. [T.D. 7750, 45 FR 1721, Jan. 7, 1981] 1.501(c)(9)2 Membership in a vol-untary employees beneficiary asso-ciation; employees; voluntary asso-ciation of employees. (a) Membership(1) In general. The membership of an organization de-scribed in section 501(c)(9) must consist of individuals who become entitled to participate by reason of their being employees and whose eligibility for membership is defined by reference to objective standards that constitute an employment-related common bond among such individuals. Typically, those eligible for membership in an or-ganization described in section 501(c)(9) are defined by reference to a common employer (or affiliated employers), to coverage under one or more collective bargaining agreements (with respect to benefits provided by reason of such agreement(s)), to membership in a labor union, or to membership in one or more locals of a national or inter-national labor union. For example, membership in an association might be open to all employees of a particular employer, or to employees in specified job classifications working for certain employers at specified locations and who are entitled to benefits by reason of one or more collective bargaining agreements. In addition, employees of one or more employers engaged in the same line of business in the same geo-graphic locale will be considered to share an employment-related bond for purposes of an organization through which their employers provide benefits. Employees of a labor union also will be considered to share an employment-re-lated common bond with members of the union, and employees of an associa-tion will be considered to share an em-ployment-related common bond with members of the association. Whether a VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00034 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15025 Internal Revenue Service, Treasury 1.501(c)(9)2 group of individuals is defined by ref-erence to a permissible standard or standards is a question to be deter-mined with regard to all the facts and circumstances, taking into account the guidelines set forth in this paragraph. Exemption will not be denied merely because the membership of an associa-tion includes some individuals who are not employees (within the meaning of paragraph (b) of this section), provided that such individuals share an employ-ment-related bond with the employee- members. Such individuals may in-clude, for example, the proprietor of a business whose employees are members of the association. For purposes of the preceding two sentences, an associa-tion will be considered to be composed of employees if 90 percent of the total membership of the association on one day of each quarter of the associations taxable year consists of employees (within the meaning of paragraph (b) of this section). (2) Restrictions(i) In general. Eligi-bility for membership may be re-stricted by geographic proximity, or by objective conditions or limitations rea-sonably related to employment, such as a limitation to a reasonable classi-fication of workers, a limitation based on a reasonable minimum period of service, a limitation based on max-imum compensation, or a requirement that a member be employed on a full- time basis. Similarly, eligibility for benefits may be restricted by objective conditions relating to the type or amount of benefits offered. Any objec-tive criteria used to restrict eligibility for membership or benefits may not, however, be selected or administered in a manner that limits membership or benefits to officers, shareholders, or highly compensated employees of an employer contributing to or otherwise funding the employees association. Similarly, eligibility for benefits may not be subject to conditions or limita-tions that have the effect of entitling officers, shareholders, or highly com-pensated employees of an employer contributing to or otherwise funding the employees association to benefits that are disproportionate in relation to benefits to which other members of the association are entitled. See 1.501(c)(9)4(b). Whether the selection or administration of objective condi-tions has the effect of providing dis-proportionate benefits to officers, shareholders, or highly compensated employees generally is to be deter-mined on the basis of all the facts and circumstances. (ii) Generally permissible restrictions or conditions. In general the following re-strictions will not be considered to be inconsistent with 1.501(c)(9)2(a)(2)(i) or 1.501(c)(9)4(b): (A) In the case of an employer-funded organization, a provision that excludes or has the effect of excluding from membership in the organization or par-ticipation in a particular benefit plan employees who are members of another organization or covered by a different plan, funded or contributed to by the employer, to the extent that such other organization or plan offers simi-lar benefits on comparable terms to the excluded employees. (B) In the case of an employer fund-ed-organization, a provision that ex-cludes from membership, or limits the type or amount of benefits provided to, individuals who are included in a unit of employees covered by an agreement which the Secretary of Labor finds to be a collective bargaining agreement between employee representatives and one or more employers, if there is evi-dence that the benefit or benefits pro-vided by the organization were the sub-ject of good faith bargaining between such employee representatives and such employer or employers. (C) Restrictions or conditions on eli-gibility for membership or benefits that are determined through collective bargaining, by trustees designated pur-suant to a collective bargaining agree-ment, or by the collective bargaining agents of the members of an associa-tion or trustees named by such agent or agents. (D) The allowance of benefits only on condition that a member or recipient contribute to the cost of such benefits, or the allowance of different benefits based solely on differences in contribu-tions, provided that those making equal contributions are entitled to comparable benefits. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00035 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15026 26 CFR Ch. I (4113 Edition) 1.501(c)(9)2 (E) A requirement that a member (or a members dependents) meet a reason-able health standard related to eligi-bility for a particular benefit. (F) The provision of life benefits in amounts that are a uniform percentage of the compensation received by the in-dividual whose life is covered. (G) The provision of benefits in the nature of wage replacement in the event of disability in amounts that are a uniform percentage of the compensa-tion of the covered individuals (either before or after taking into account any disability benefits provided through so-cial security or any similar plan pro-viding for wage replacement in the event of disability). (3) Examples. The provisions of this section may be illustrated by the fol-lowing examples: Example 1. Pursuant to a collective bar-gaining agreement entered into by X Cor-poration and W, a labor union which rep-resents all of X Corporations hourly-paid employees, the X Corporation Union Benefit Plan is established to provide life insurance benefits to employees of X represented by W. The Plan is funded by contributions from X, and is jointly administered by X and W. In order to provide its non-unionized employees with comparable life insurance benefits, X also establishes and funds the X Corporation Life Insurance Trust. The Trust will not be ineligible for exemption as an organization described in section 501(c)(9) solely because membership is restricted to those employees of X who are not members of W. Example 2. The facts are the same as in Ex-ample 1 except that the life insurance ben-efit provided to the non-unionized employees of X differs from the life insurance benefit provided to the unionized employees of X pursuant to the collective bargaining agree-ment. The trust will not be ineligible for ex-emption as an organization described in sec-tion 501(c)(9) solely because the life insur-ance benefit provided to Xs nonunionized employees is not same as the life insurance benefit provided to Xs unionized employees. Example 3. S corporation established a plan to provide health benefits to all its employ-ees. In accordance with the provisions of the plan each employee may secure insurance coverage by making an election under which the employee agrees to contribute periodi-cally to the plan an amount which is deter-mined solely by whether the employee elects a high option coverage or a low option cov-erage and on whether the employee is un-married or has a family. As an alternative, the employee may elect high or low options, self only or self and family, coverage through a local prepaid group medical plan. The contributions required of those electing the prepaid group medical plan also vary with the type of coverage selected, and differ from those required of employees electing in-surance. The difference between the amount contributed by employees electing the var-ious coverages and the actual cost of pur-chasing the coverage is made up through contributions by S to the plan, and under the plan, S provides approximately the same proportion of the cost for each coverage. To fund the plan, S established an arrangement in the nature of a trust under applicable local law and contributes all employee con-tributions, and all amounts which by the terms of the plan it is required to contribute, to the trust. The terms of the plan do not provide for disproportionate benefits to the employees of S and will not be considered in-consistent with 1.501(c)(9)2(a)(2)(i). Example 4. The facts are the same as in Ex-ample 3 except that, for those employees or former employees covered by Medicare, the plan provides a distinct coverage which sup-plements Medicare benefits. Eligibility for Medicare is an objective condition relating to a type of benefit offered, and the provision of separate coverage for those eligible for Medicare will not be considered inconsistent with 1.501(c)(9)2(a)(2)(i). (b) Meaning of employee. Whether an individual is an employee is determined by reference to the legal and bona fide relationship of employer and employee. The term employee includes the fol-lowing: (1) An individual who is considered an employee: (i) For employment tax purposes under subtitle C of the Internal Rev-enue Code and the regulations there-under, or (ii) For purposes of a collective bar-gaining agreement, whether or not the individual could qualify as an employee under applica-ble common law rules. This would in-clude any person who is considered an employee for purposes of the Labor Management Relations Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 141 (1979). (2) An individual who became enti-tled to membership in the association by reason of being or having been an employee. Thus, an individual who would otherwise qualify under this paragraph will continue to qualify as an employee even though such indi-vidual is on leave of absence, works temporarily for another employer or as VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00036 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15027 Internal Revenue Service, Treasury 1.501(c)(9)2 an independent contractor, or has been terminated by reason of retirement, disability or layoff. For example, an in-dividual who in the normal course of employment is employed intermit-tently by more than one employer in an industry characterized by short- term employment by several different employers will not, by reason of tem-porary unemployment, cease to be an employee within the meaning of this paragraph. (3) The surviving spouse and depend-ents of an employee (if, for purposes of the 90-percent test of 1.501(c)(9)2(a)(1) they are considered to be members of the association). (c) Description of voluntary association of employees(1) Association. To be de-scribed in section 501(c)(9) and this sec-tion there must be an entity, such as a corporation or trust established under applicable local law, having an exist-ence independent of the member-em-ployees or their employer. (2) Voluntary. Generally, membership in an association is voluntary if an af-firmative act is required on the part of an employee to become a member rath-er than the designation as a member due to employee status. However, an association shall be considered vol-untary although membership is re-quired of all employees, provided that the employees do not incur a detriment (for example, in the form of deductions from pay) as the result of membership in the association. An employer is not deemed to have imposed involuntary membership on the employee if mem-bership is required as the result of a collective bargaining agreement or as an incident of membership in a labor organization. (3) Of employees. To be described in this section, an organization must be controlled (i) By its membership, (ii) By independent trustee(s) (such as a bank), or (iii) By trustees or other fiduciaries at least some of whom are designated by, or on behalf of, the membership. Whether control by or on behalf of the membership exists is a question to be determined with regard to all of the facts and circumstances, but generally such control will be deemed to be present when the membership (either directly or through its representative) elects, appoints or otherwise des-ignates a person or persons to serve as chief operating officer(s), adminis-trator(s), or trustee(s) of the organiza-tion. For purposes of this paragraph an organization will be considered to be controlled by independent trustees if it is an employee welfare benefit plan, as defined in section 3(1) of the Employee Retirement Income Security Act of 1974 (ERISA), and, as such, is subject to the requirements of parts 1 and 4 of subtitle B, title I of ERISA. Similarly, a plan will be considered to be con-trolled by its membership if it is con-trolled by one or more trustees des-ignated pursuant to a collective bar-gaining agreement (whether or not the bargaining agent of the represented employees bargained for and obtained the right to participate in selecting the trustees). (4) Examples. The provisions of this section may be illustrated by the fol-lowing examples: Example 1. X, a labor union, represents all the hourly-paid employees of Y Corporation. A health insurance benefit plan was estab-lished by X and Y as the result of a collec-tive bargaining agreement entered into by them. The plan established the terms and conditions of membership in, and the bene-fits to be provided by, the plan. In accord-ance with the terms of the agreement, Y Cor-poration is obligated to establish a trust fund and make contributions thereto at spec-ified rates. The trustees, some of whom are designated by X and some by Y, are author-ized to hold and invest the assets of the trust and to make payments on instructions issued by Y Corporation in accordance with the conditions contained in the plan. The interdependent benefit plan agreement and trust indenture together create a voluntary employees beneficiary association over which the employees posses the requisite control through the trustees designated by their representative, X. Example 2. Z Corporation unilaterally es-tablished an educational benefit plan for its employees. The purpose of the plan is to pro-vide payments for job-related educational or training courses, such as apprenticeship training programs, for Z Corporation em-ployees, according to objective criteria set forth in the plan. Z establishes a separate bank account which it uses to fund payments to the plan. Contributions to the account are to be made at the discretion of and solely by Z Corporation, which also administers the plan and retains control over the assets in the fund. Z Corporations educational benefit VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00037 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15028 26 CFR Ch. I (4113 Edition) 1.501(c)(9)3 plan and the related account do not con-stitute an association having an existence independent of Z Corporation and therefore do not constitute a voluntary employees beneficiary association. Example 3. A, an individual, is the incorpo-rator and chief operating officer of Lawyers Beneficiary Association (LBA). LBA is en-gaged in the business of providing medical benefits to members of the Association and their families. Membership is open only to practicing lawyers located in a particular metropolitan area who are neither self-em-ployed nor partners in a law firm. Member-ship in LBA is solicited by insurance agents under the control of X Corporation (owned by A) which, by contract with LBA, is the exclusive sales agent. Medical benefits are paid from a trust account containing peri-odic contributions paid by the members, to-gether with proceeds from the investment of those contributions. Contribution and ben-efit levels are set by LBA. The members of LBA do not hold meetings, have no right to elect officers or directors of the Association, and no right to replace trustees. Collec-tively, the subscribers for medical benefits from LBA cannot be said to control the asso-ciation and membership is neither more than nor different from the purchase of an insur-ance policy from a stock insurance company. LBA is not a voluntary employees bene-ficiary association. Example 4. U corporation unilaterally es-tablished a plan to provide benefits to its employees. In accordance with the provisions of the plan, each employee may secure insur-ance or benefit coverage by making an elec-tion under which the employee agrees to contribute to the plan an amount which is determined solely by whether the employee elects a high option coverage or a low option coverage and on whether the employee elects self only or self and family coverage. The dif-ference between the amount contributed by employees electing the various coverages and the actual cost of the coverage is made up through contributions by U to the plan. To fund the plan, U established an arrange-ment in the nature of a trust under applica-ble local law and contributed all employee contributions, and all amounts which by the term of the plan it was required to provide to the plan, to the trust. The trust constitutes an employee welfare benefit plan within the meaning of, and subject to relevant require-ments of, ERISA. It will be considered to meet the requirements of 1.501(c)(9)2(c)(3). [T.D. 7750, 46 FR 1723, Jan. 7, 1981] 1.501(c)(9)3 Voluntary employees beneficiary associations; life, sick, accident, or other benefits. (a) In general. The life, sick, accident, or other benefits provided by a vol-untary employees beneficiary associa-tion must be payable to its members, their dependents, or their designated beneficiaries. For purposes of section 501(c)(9), dependent means the mem-bers spouse; any child of the member or the members spouse who is a minor or a student (within the meaning of section 151(e)(4)); any other minor child residing with the member; and any other individual who an association, relying on information furnished to it by a member, in good faith believes is a person described in section 152(a). Life, sick, accident, or other benefits may take the form of cash or noncash benefits. A voluntary employees bene-ficiary association is not operated for the purpose of providing life, sick, acci-dent, or other benefits unless substan-tially all of its operations are in fur-therance of the provision of such bene-fits. Further, an organization is not de-scribed in this section if it systemati-cally and knowingly provides benefits (of more than a de minimis amount) that are not permitted by paragraphs (b), (c), (d), or (e) of this section. (b) Life benefits. The term life benefits means a benefit (including a burial benefit or a wreath) payable by reason of the death of a member or dependent. A life benefit may be provided directly or through insurance. It generally must consist of current protection, but also may include a right to convert to individual coverage on termination of eligibility for coverage through the as-sociation, or a permanent benefit as de-fined in, and subject to the conditions in, the regulations under section 79. A life benefit also includes the benefit pro-vided under any life insurance contract purchased directly from an employee- funded association by a member or pro-vided by such an association to a mem-ber. The term life benefit does not in-clude a pension, annuity or similar benefit, except that a benefit payable by reason of the death of an insured may be settled in the form of an annu-ity to the beneficiary in lieu of a lump- sum death benefit (whether or not the contract provides for settlement in a lump sum). (c) Sick and accident benefits. The term sick and accident benefits means amounts furnished to or on behalf of a member or a members dependents in VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00038 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15029 Internal Revenue Service, Treasury 1.501(c)(9)3 the event of illness or personal injury to a member or dependent. Such bene-fits may be provided through reim-bursement to a member or a members dependents for amounts expended be-cause of illness or personal injury, or through the payment of premiums to a medical benefit or health insurance program. Similarly, a sick and acci-dent benefit includes an amount paid to a member in lieu of income during a period in which the member is unable to work due to sickness or injury. Sick benefits also include benefits designed to safeguard or improve the health of members and their dependents. Sick and accident benefits may be provided directly by an association to or on be-half of members and their dependents, or may be provided indirectly by an as-sociation through the payment of pre-miums or fees to an insurance com-pany, medical clinic, or other program under which members and their de-pendents are entitled to medical serv-ices or to other sick and accident bene-fits. Sick and accident benefits may also be furnished in noncash form, such as, for example, benefits in the nature of clinical care services by visiting nurses, and transportation furnished for medical care. (d) Other benefits. The term other ben-efits includes only benefits that are similar to life, sick, or accident bene-fits. A benefit is similar to a life, sick, or accident benefit if: (1) It is intended to safeguard or im-prove the health of a member or a members dependents, or (2) It protects against a contingency that interrupts or impairs a members earning power. (e) Examples of other benefits. Paying vacation benefits, providing vacation facilities, reimbursing vacation ex-penses, and subsidizing recreational ac-tivities such as athletic leagues are considered other benefits. The provision of child-care facilities for preschool and school-age dependents are also con-sidered other benefits. The provision of job readjustment allowances, income maintenance payments in the event of economic dislocation, temporary living expense loans and grants at times of disaster (such as fire or flood), supple-mental unemployment compensation benefits (as defined in section 501(c)(17)(D)(i) of the Code), severance benefits (under a severance pay plan within the meaning of 29 CFR 2510.3 2(b)) and education or training benefits or courses (such as apprentice training programs) for members, are considered other benefits because they protect against a contingency that interrupts earning power. Personal legal service benefits which consist of payments or credits to one or more organizations or trusts described in section 501(c)(20) are considered other benefits. Except to the extent otherwise provided in these reg-ulations, as amended from time to time, other benefits also include any benefit provided in the manner per-mitted by paragraphs (5) et seq. of sec-tion 302(c) of the Labor Management Relations Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 186(c) (1979). (f) Examples of nonqualifying benefits. Benefits that are not described in para-graphs (d) or (e) of this section are not other benefits. Thus, other benefits do not include the payment of commuting expenses, such as bridge tolls or train fares, the provision of accident or homeowners insurance benefits for damage to property, the provision of malpractice insurance, or the provision of loans to members except in times of distress (as permitted by 1.501(c)(9) 3(e)). Other benefits also do not include the provision of savings facilities for members. The term other benefits does not include any benefit that is similar to a pension or annuity payable at the time of mandatory or voluntary retire-ment, or a benefit that is similar to the benefit provided under a stock bonus or profit-sharing plan. For purposes of section 501(c)(9) and these regulations, a benefit will be considered similar to that provided under a pension, annuity, stock bonus or profit-sharing plan if it provides for deferred compensation that becomes payable by reason of the passage of time, rather than as the re-sult of an unanticipated event. Thus, for example, supplemental unemploy-ment benefits, which generally become payable by reason of unanticipated lay-off, are not, for purposes of these regu-lations, considered similar to the ben-efit provided under a pension, annuity, stock bonus or profit-sharing plan. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00039 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15030 26 CFR Ch. I (4113 Edition) 1.501(c)(9)4 (g) Examples. The provisions of this section may be further illustrated by the following examples: Example 1. V was organized in connection with a vacation plan created pursuant to a collective bargaining agreement between M, a labor union, which represents certain hour-ly paid employees of T corporation, and T. The agreement calls for the payment by T to V of a specified sum per hour worked by T employees who are covered by the collective bargaining agreement. T includes the amounts in the covered employees wages and withholds income and FICA taxes. The amounts are paid by T to V to provide vaca-tion benefits provided under the collective bargaining agreement. Generally, each cov-ered employee receives a check in payment of his or her vacation benefit during the year following the year in which contributions were made by T to V. The amount of the va-cation benefit is determined by reference to the contributions during the prior year to V by T on behalf of each employee, and is dis-tributed in cash to each such employee. If the earnings on investments by V during the year preceding distribution are sufficient after deducting the expenses of admin-istering the plan, each recipient of a vaca-tion benefit is paid an amount, in addition to the contributions on his or her behalf, equal to his/her ratable share of the net earnings of V during such year. The plan provides a va-cation benefit that constitutes an eligible other benefit described in section 501(c)(9) and 1.501(c)(9)3(e). Example 2. The facts are the same as in Ex-ample 1, except that each covered employee of T is entitled, at his or her discretion, to contribute up to an additional $1,000 each year to V, which agrees in respect of such sum to pay interest at a stated rate from the time of contribution until the time at which the contributing employees vacation benefit is distributed. In addition, each employee may elect to leave all or a portion of his/her distributable benefit on deposit past the time of distribution, in which case interest will continue to accrue. Because the plan more closely resembles a savings arrange-ment than a vacation plan, the benefit pay-able to the covered employees of T is not a vacation benefit and is not an eligible other benefit described in section 501(c)(9) and 1.501(c)(9)3 (d) or (e). [T.D. 7750, 46 FR 1724, Jan. 7, 1981] 1.501(c)(9)4 Voluntary employees beneficiary associations; inurement. (a) General rule. No part of the net earnings of an employees association may inure to the benefit of any private shareholder or individual other than through the payment of benefits per-mitted by 1.501(c)(9)3. The disposition of property to, or the performance of services for, a person for less than the greater of fair market value or cost (in-cluding indirect costs) to the associa-tion, other than as a life, sick, accident or other permissible benefit, con-stitutes prohibited inurement. Gen-erally, the payment of unreasonable compensation to the trustees or em-ployees of the association, or the pur-chase of insurance or services for amounts in excess of their fair market value from a company in which one or more of the associations trustees, offi-cers or fiduciaries has an interest, will constitute prohibited inurement. Whether prohibited inurement has oc-curred is a question to be determined with regard to all of the facts and cir-cumstances, taking into account the guidelines set forth in this section. The guidelines and examples contained in this section are not an exhaustive list of the activities that may constitute prohibited inurement, or the persons to whom the associations earnings could impermissibly inure. See 1.501(a)1(c). (b) Disproportionate benefits. For pur-poses of subsection (a), the payment to any member of disproportionate bene-fits, where such payment is not pursu-ant to objective and nondiscriminatory standards, will not be considered a ben-efit within the meaning of 1.501(c)(9) 3 even though the benefit otherwise is one of the type permitted by that sec-tion. For example, the payment to highly compensated personnel of bene-fits that are disproportionate in rela-tion to benefits received by other mem-bers of the association will constitute prohibited inurement. Also, the pay-ment to similarly situated employees of benefits that differ in kind or amount will constitute prohibited inurement unless the difference can be justified on the basis of objective and reasonable standards adopted by the association or on the basis of standards adopted pursuant to the terms of a col-lective bargaining agreement. In gen-eral, benefits paid pursuant to stand-ards or subject to conditions that do not provide for disproportionate bene-fits to officers, shareholders, or highly compensated employees will not be considered disproportionate. See 1.501(c)(9)2(a) (2) and (3). VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00040 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15031 Internal Revenue Service, Treasury 1.501(c)(9)6 (c) Rebates. The rebate of excess in-surance premiums, based on the mor-tality or morbidity experience of the insurer to which the premiums were paid, to the person or persons whose contributions were applied to such pre-miums, does not constitute prohibited inurement. A voluntary employees beneficiary association may also make administrative adjustments strictly in-cidental to the provision of benefits to its members. (d) Termination of plan or dissolution of association. It will not constitute pro-hibited inurement if, on termination of a plan established by an employer and funded through an association de-scribed in section 501(c)(9), any assets remaining in the association, after sat-isfaction of all liabilities to existing beneficiaries of the plan, are applied to provide, either directly or through the purchase of insurance, life, sick, acci-dent or other benefits within the mean-ing of 1.501(c)(9)3 pursuant to criteria that do not provide for dispropor-tionate benefits to officers, share-holders, or highly compensated em-ployees of the employer. See 1.501(c)(9)2(a)(2). Similarly, a dis-tribution to members upon the dissolu-tion of the association will not con-stitute prohibited inurement if the amount distributed to members are de-termined pursuant to the terms of a collective bargaining agreement or on the basis of objective and reasonable standards which do not result in either unequal payments to similarly situated members or in disproportionate pay-ments to officers, shareholders, or highly compensated employees of an employer contributing to or otherwise funding the employees association. Except as otherwise provided in the first sentence of this paragraph, if the associations corporate charter, arti-cles of association, trust instrument, or other written instrument by which the association was created, as amend-ed from time to time, provides that on dissolution its assets will be distrib-uted to its members contributing em-ployers, or if in the absence of such provision the law of the state in which the association was created provides for such distribution to the contrib-uting employers, the association is not described in section 501(c)(9). (e) Example. The provisions of this section may be illustrated by the fol-lowing example: Example. Employees A, B and C, members of the X voluntary employees beneficiary association, are unemployed. They receive unemployment benefits from X. Those to A include an amount in addition to those pro-vided to B and C, to provide for As retrain-ing. B has been found pursuant to objective and reasonable standards not to qualify for the retraining program. C, although eligible for retraining benefits has declined. Xs addi-tional payment to A for retraining does not constitute prohibited inurement. [T.D. 7750, 46 FR 1725, Jan. 7, 1981] 1.501(c)(9)5 Voluntary employees beneficiary associations; record-keeping requirements. (a) Records. In addition to such other records which may be required (for ex-ample, by section 512(a)(3) and the reg-ulations thereunder), every organiza-tion described in section 501(c)(9) must maintain records indicating the amount contributed by each member and contributing employer, and the amount and type of benefits paid by the organization to or on behalf of each member. (b) Cross reference. For provisions re-lating to annual information returns with respect to payments, see section 6041 and the regulations thereunder. [T.D. 7750, 46 FR 1725, Jan. 7, 1981] 1.501(c)(9)6 Voluntary employees beneficiary associations; benefits includible in gross income. (a) In general. Cash and noncash bene-fits realized by a person on account of the activities of an organization de-scribed in section 501(c)(9) shall be in-cluded in gross income to the extent provided in the Internal Revenue Code of 1954, including, but not limited to, sections 61, 72, 101, 104 and 105 of the Code and regulations thereunder. (b) Availability of statutory exclusions from gross income. The availability of any statutory exclusion from gross in-come with respect to contributions to, or the payment of benefits from, an or-ganization described in section 501(c)(9) is determined by the statutory provi-sion conferring the exclusion, and the regulations and rulings thereunder, not by whether an individual is eligible for VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00041 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15032 26 CFR Ch. I (4113 Edition) 1.501(c)(9)7 membership in the organization or by the permissibility of the benefit paid. Thus, for example, if a benefit is paid by an employer-funded organization described in section 501(c)(9) to a mem-ber who is not an employee, a statutory exclusion from gross income that is available only for employees would be unavailable in the case of a benefit paid to such individual. Similarly, the fact that, for example, under some cir-cumstances educational benefits con-stitute other benefits does not of itself mean that such benefits are eligible for the exclusion of either section 117 or section 127 of the Code. [T.D. 7750, 46 FR 1725, Jan. 7, 1981] 1.501(c)(9)7 Voluntary employees beneficiary associations; section 3(4) of ERISA. The term voluntary employees bene-ficiary association in section 501(c)(9) of the Internal Revenue Code is not nec-essarily coextensive with the term em-ployees beneficiary association as used in section 3(4) of the Employee Retire-ment Income Security Act of 1974 (ERISA), 29 U.S.C. 1002(4), and the re-quirements which an organization must meet to be an employees bene-ficiary association within the meaning of section 3(4) of ERISA are not nec-essarily identical to the requirements that an organization must meet in order to be a voluntary employees bene-ficiary association within the meaning of section 501(c)(9) of the Code. [T.D. 7750, 46 FR 1725, Jan. 7, 1981] 1.501(c)(9)8 Voluntary employees beneficiary associations; effective date. (a) General rule. Except as otherwise provided in this section, the provisions of 1.501(c)(9)1 through 1.501(c)(9)7 shall apply with respect to taxable years beginning after December 31, 1954. (b) Pre-1970 taxable years. For taxable years beginning before January 1, 1970, section 501(c)(9)(B) (relating to the re-quirement that 85 percent or more of the associations income consist of amounts collected from members and contributed by employers), as in effect for such years, shall apply. (c) Existing associations. Except as otherwise provided in paragraph (d), the provisions of 1.501(c)(9)2(a)(1) and (c)(3) shall apply with respect to tax-able years beginning after December 31, 1980. (d) Collectively-bargained plans. In the case of a voluntary employees bene-ficiary association which receives con-tributions from one or more employers pursuant to one or more collective bar-gaining agreements in effect on Decem-ber 31, 1980, the provisions of 1.501(c)(9)1 through 1.501(c)(9)5 shall apply with respect to taxable years be-ginning after the date on which the agreement terminates (determined without regard to any extension there-of agreed to after December 31, 1980). (e) Election. Notwithstanding para-graphs (c) and (d) of this section, an or-ganization may choose to be subject to all or a portion of one or more of the provisions of these regulations for any taxable year beginning after December 31, 1954. [T.D. 7750, 46 FR 1725, Jan. 7, 1981; 46 FR 11971, Feb. 12, 1981] 1.501(c)(10)1 Certain fraternal bene-ficiary societies. (a) For taxable years beginning after December 31, 1969, an organization will qualify for exemption under section 501(c)(10) if it: (1) Is a domestic fraternal beneficiary society order, or association, described in section 501(c)(8) and the regulations thereunder except that it does not pro-vide for the payment of life, sick, acci-dent, or other benefits to its members, and (2) Devotes its net earnings exclu-sively to religious, charitable, sci-entific, literary, educational, and fra-ternal purposes Any organization described in section 501(c)(7), such as, for example, a na-tional college fraternity, is not de-scribed in section 501(c)(10) and this section. [T.D. 7172, 37 FR 5618, Mar. 17, 1972] 1.501(c)(12)1 Local benevolent life insurance associations, mutual irri-gation and telephone companies, and like organizations. (a) An organization described in sec-tion 501(c)(12) must receive at least 85 percent of its income from amounts VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00042 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15033 Internal Revenue Service, Treasury 1.501(c)(13)1 collected from members for the sole purpose of meeting losses and expenses. If an organization issues policies for stipulated cash premiums, or if it re-quires advance deposits to cover the cost of the insurance and maintains in-vestments from which more than 15 percent of its income is derived, it is not entitled to exemption. On the other hand, an organization may be entitled to exemption, although it makes ad-vance assessments for the sole purpose of meeting future losses and expenses, provided that the balance of such as-sessments remaining on hand at the end of the year is retained to meet losses and expenses or is returned to members. (b) The phrase of a purely local char-acter applies to benevolent life insur-ance associations, and not to the other organizations specified in section 501(c)(12). It also applies to any organi-zation seeking exemption on the ground that it is an organization simi-lar to a benevolent life insurance asso-ciation. An organization of a purely local character is one whose business activities are confined to a particular community, place, or district, irrespec-tive, however, of political subdivisions. If the activities of an organization are limited only by the borders of a State it cannot be considered to be purely local in character. (c) For taxable years of a mutual or cooperative telephone company begin-ning after December 31, 1974, the 85 per-cent member-income test described in paragraph (a) of this section is applied without taking into account income re-ceived or accrued from another tele-phone company for the performance of communication services involving the completion of long distance calls to, from, or between members of the mu-tual or cooperative telephone com-pany. For example, if, in one year, a cooperative telephone company re-ceives $85x from its members for tele-phone calls, $15x as interest income, and $20x as credits under long distance interconnection agreements with other telephone companies for the perform-ance of communication services involv-ing the completion of long distance calls to, from, or between the coopera-tives members (whether or not the credits may be offset, in whole or in part, by amounts due the other compa-nies under the interconnection agree-ments), the member-income fraction is calculated without taking into ac-count, either in the numerator or de-nominator, the $20x credits received from the other telephone companies. In this example, the 85 percent member- income test is satisfied because at least 85 percent member incometotal income=+= =8585 1585100 85%xx xof the cooperatives total income is de-rived from member income. [T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as amended at 44 FR 59523, Oct. 16, 1979] 1.501(c)(13)1 Cemetery companies and crematoria. (a) Nonprofit mutual cemetery compa-nies. A nonprofit cemetery company may be entitled to exemption if it is owned by and operated exclusively for the benefit of its lot owners who hold such lots for bona fide burial purposes and not for the purpose of fesale. A mu-tual cemetery company which also en-gages in charitable activities, such as burial of paupers, will be regarded as operating in conformity with this standard. Further, the fact that a mu-tual cemetery company limits its membership to a particular class of in-dividuals, such as members of a family, will not affect its status as mutual so long as all the other requirements of section 501(c)(13) are met. (b) Nonprofit cemetery companies and crematoria. Any nonprofit corporation, chartered solely for the purpose of the burial, or (for taxable years beginning after December 31, 1970) the cremation of bodies, and not permitted by its charter to engage in any business not necessarily incident to that purpose, is exempt from income tax, provided that no part of its net earnings inures to the benefit of any private shareholder or individual. (c) Preferred stock(1) In general. Ex-cept as provided in subparagraph (3) of this paragraph, a cemetery company or crematorium is not described in sec-tion 501(c)(13) if it issues preferred stock on or after November 28, 1978. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00043 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150EC14NO91.158</MATH>34 26 CFR Ch. I (4113 Edition) 1.501(c)(14)1 (2) Transitional rule for preferred stock issued prior to November 28, 1978. In the case of preferred stock issued prior to November 28, 1978, a cemetery company or crematorium which issued such stock shall not fail to be exempt from income tax solely because it issued pre-ferred stock which entitled the holders to dividends at a fixed rate, not exceed-ing the legal rage of interest in the State of incorporation or 8 percent per annum, whichever is greater, on the value of the consideration for which the stock was issued, if its articles of incorporation require: (i) That the preferred stock be retired at par as rapidly as funds therefor be-come available from operations, and (ii) That all funds not required for the payment of dividends upon or for the retirement of preferred stock be used by the company for the care and inprovement of the cemetery property. The term legal rate of interest shall mean the rate of interest prescribed by law in the State of incorporation which prevails in the absence of an agreement between contracting parties fixing a rate. (3) Transitional rule for preferred stock issued on or after November 28, 1978. In the case of preferred stok issued on or after November 28, 1978, a cemetery company or crematorium shall not fail to be exempt from income tax if its ar-ticles of incorporation and the pre-ferred stock meet the requirements of paragraph (c)(2) and if such stock is issued pursuant to a plan which has been reduced to writing and adopted prior to November 28, 1978. The adop-tion of the plan must be shown by the acts of the duly constituted responsible officers and appear upon the official records of the cemetery company or crematorium. (d) Sales to exempt cemetery companies and crematoria. Except as provided in paragraph (c)(2) or (c)(3) of this section (relating to transitional rules for pre-ferred stock), no person may have any interest in the net earnings of a tax-ex-empt cemetery company or cremato-rium. Thus, a cemetery company or crematorium is not exempt from tax if property is transferred to such organi-zation in exchange for an interest in the net earnings of the organization so long as such interest remains out-standing. An interest in a cemetery company or crematorium that con-stitutes an equity interest within the meaning of section 385 will be consid-ered an interest in the net earnings of the cemetery. However, an interest in a cemetery company or crematorium that does not constitute an equity in-terest within the meaning of section 385 may nevertheless constitute an in-terest in the net earning of the organi-zation. Thus, for example, a bond or other evidence of indebtedness issued by a cemetery company or cremato-rium which provides for a fixed rate of interest but which, in addition, pro-vides for additional interest payments contingent upon the revenues or in-come of the organization is considered an interest in the net earnings of the organization. Similarly, a convertible debt obligation issued by a cemetery company or crematorium after July 7, 1975, is considered an interest in the net earnings of the organization. [T.D. 7698, 45 FR 33972, May 21, 1980] 1.501(c)(14)1 Credit unions and mu-tual insurance funds. Credit unions (other than Federal credit unions described in section 501(c)(1)) without capital stock, orga-nized and operated for mutual purposes and without profit, are exempt from tax under section 501(a). Corporations or associations without capital stock organized before September 1, 1951 and operated for mutual purposes and with-out profit for the purpose of providing reserve funds for, and insurance of, shares or deposits in: (a) Domestic building and loan asso-ciations as defined in section 7701(a)(19), (b) Cooperative banks without cap-ital stock organized and operated for mutual purposes and without profit, or (c) Mutual savings banks not having capital stock represented by shares are also exempt from tax under section 501(a). In addition, corporations or as-sociations of the type described in the preceding sentence which were orga-nized on or after September 1, 1951, but before September 1, 1957, are exempt VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00044 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15035 Internal Revenue Service, Treasury 1.501(c)(16)1 from tax under section 501(a) for tax-able years beginning after December 31, 1959. [T.D. 6493, 25 FR 9219, Sept. 27, 1960] 1.501(c)(15)1 Mutual insurance com-panies or associations. (a) Taxable years beginning after De-cember 31, 1962. An insurance company or association described in section 501(c)(15) is exempt under section 501(a) if it is a mutual company or associa-tion (other than life or marine) or if it is a mutual interinsurer or reciprocal underwriter (other than life or marine) and if the gross amount received dur-ing the taxable year from the sum of the following items does not exceed $150,000: (1) The gross amount of income dur-ing the taxable year from: (i) Interest (including tax-exempt in-terest and partially tax-exempt inter-est), as described in 1.617. Interest shall be adjusted for amortization of premium and accrual of discount in ac-cordance with the rules prescribed in section 822(d)(2) and the regulations thereunder. (ii) Dividends, as described in 1.619. (iii) Rents and royalties, as described in 1.618. (iv) The entering into of any lease, mortgage, or other instrument or agreement from which the company may derive interest, rents, or royalties. (v) The alteration or termination of any instrument or agreement described in subdivision (iv) of this subpara-graph. (2) The gross income from any trade or business (other than an insurance business) carried on by the company or association, or by a partnership of which the company or association is a partner. (3) Premiums (including deposits and assessments). (b) Taxable years beginning after De-cember 31, 1954, and before January 1, 1963. An insurance company or associa-tion described in section 501(c)(15) and paragraph (a) of this section is exempt under section 501(a) if the gross amount received during the taxable year from the sum of the items de-scribed in paragraph (a) (1), (2), and (3) of this section does not exceed $75,000. (c) No double inclusion of income. In computing the gross income from any trade or business (other than an insur-ance business) carried on by the com-pany or association, or by a partner-ship of which the company or associa-tion is a partner, any item described in section 822(b)(1) (A), (B), or (C) and paragraph (a)(1) of this section shall not be considered as gross income aris-ing from the conduct of such trade or business, but shall be taken into ac-count under section 822(b)(1) (A), (B), or (C) and paragraph (a)(1) of this section. (d) Taxable years beginning after De-cember 31, 1953, and before January 1, 1955. An insurance company or associa-tion described in section 501(c)(15) is exempt under section 501(a) if it is a mutual company or association (other than life or marine) or if it is a mutual interinsurer or reciprocal underwriter (other than life or marine) and if the gross amount received during the tax-able year from the sum of the following items does not exceed $75,000: (1) The gross amount of income dur-ing the taxable year from (i) Interest (including tax-exempt in-terest and partially tax-exempt inter-est), as described in 1.617. Interest shall be adjusted for amortization of premium and accrual of discount in ac-cordance with the rules prescribed in section 822(d)(2) and 1.8223. (ii) Dividends, as described in 1.619. (iii) Rents (but excluding royalties), as described in 1.618. (2) Premiums (including deposits and assessments). (e) Exclusion of capital gains. Gains from sales or exchanges of capital as-sets to the extent provided in sub-chapter P (section 1201 and following, relating to capital gains and losses), chapter 1 of the Code, shall be excluded from the amounts described in this sec-tion. [T.D. 6662, 28 FR 6972, July 29, 1963] 1.501(c)(16)1 Corporations organized to finance crop operations. A corporation organized by a farm-ers cooperative marketing or pur-chasing association, or the members thereof, for the purpose of financing the ordinary crop operations of such members or other producers is exempt, provided the marketing or purchasing VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00045 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15036 26 CFR Ch. I (4113 Edition) 1.501(c)(17)1 association is exempt under section 521 and the financing corporation is oper-ated in conjunction with the mar-keting or purchasing association. The provisions of 1.5211 relating to a re-serve or surplus and to capital stock shall also apply to corporations coming under this section. 1.501(c)(17)1 Supplemental unem-ployment benefit trusts. (a) Requirements for qualification. (1) A supplemental unemployment benefit trust may be exempt as an organiza-tion described in section 501(c)(17) if the requirements of subparagraphs (2) through (6) of this paragraph are satis-fied. (2) The trust is a valid, existing trust under local law and is evidenced by an executed written document. (3) The trust is part of a written plan established and maintained by an em-ployer, his employees, or both the em-ployer and his employees, solely for the purpose of providing supplemental un-employment compensation benefits (as defined in section 501(c)(17)(D) and paragraph (b)(1) of 1.501(c)(17)1). (4) The trust is part of a plan which provides that the corpus and income of the trust cannot (in the taxable year, and at any time thereafter, before the satisfaction of all liabilities to employ-ees covered by the plan) be used for, or diverted to, any purpose other than the providing of supplemental unemploy-ment compensation benefits. Thus, if the plan provides for the payment of any benefits other than supplemental unemployment compensation benefits as defined in paragraph (b) of this sec-tion, the trust will not be entitled to exemption as an organization described in section 501(c)(17). However, the pay-ment of any necessary or appropriate expenses in connection with the admin-istration of a plan providing supple-mental unemployment compensation benefits shall be considered a payment to provide such benefits and shall not affect the qualification of the trust. (5) The trust is part of a plan whose eligibility conditions and benefits do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist of super-vising the work of other employees, or highly compensated employees. See sections 401(a)(3)(B) and 401(a)(4) and 1.4013 and 1.4014. However, a plan is not discriminatory within the meaning of section 501(c)(17)(A)(iii), relating to the requirement that the benefits paid under the plan be nondiscriminatory, merely because the benefits received under the plan bear a uniform relation-ship to the total compensation, or the basic or regular rate of compensation, of the employees covered by the plan. Accordingly, the benefits provided for highly paid employees may be greater than the benefits provided for lower paid employees if the benefits are de-termined by reference to their com-pensation; but, in such a case, the plan will not qualify if the benefits paid to the higher paid employees bear a larger ratio to their compensation than the benefits paid to the lower paid employ-ees bear to their compensation. In ad-dition, section 501(c)(17)(B) sets forth certain other instances in which a plan will not be considered discriminatory (see paragraph (c) of 1.501(c)(17)2). (6) The trust is part of a plan which requires that benefits are to be deter-mined according to objective stand-ards. Thus, a plan may provide simi-larly situated employees with benefits which differ in kind and amount, but may not permit such benefits to be de-termined solely in the discretion of the trustees. (b) Meaning of terms. The following terms are defined for purposes of sec-tion 501(c)(17): (1) Supplemental unemployment com-pensation benefits. The term supple-mental unemployment compensation bene-fits means only: (i) Benefits paid to an employee be-cause of his involuntary separation from the employment of the employer, whether or not such separation is tem-porary, but only when such separation is one resulting directly from a reduc-tion in force, the discontinuance of a plant or operation, or other similar conditions; and (ii) Sick and accident benefits subor-dinate to the benefits described in sub-division (i) of this subparagraph. (2) Employee. The term employee means an individual whose status is that of an employee under the usual VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00046 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15037 Internal Revenue Service, Treasury 1.501(c)(17)2 common-law rules applicable in deter-mining the employer-employee rela-tionship. The term employee also in-cludes an individual who qualifies as an employee under the State or Federal un-employment compensation law cov-ering his employment, whether or not such an individual could qualify as an employee under such common-law rules. (3) Involuntary separation from the em-ployment of the employer. Whether a sep-aration from the employment of the em-ployer occurs is a question to be de-cided with regard to all the facts and circumstances. However, for purposes of section 501(c)(17), the term separation includes both a temporary separation and a permanent severance of the em-ployment relationship. Thus, for exam-ple, an employee may be separated from the employment of his employer even though at the time of separation it is believed that he will be reem-ployed by the same employer. Whether or not an employee is involuntarily sep-arated from the employment of the em-ployer is a question of fact. However, normally, an employee will not be deemed to have separated himself vol-untarily from the employment of his employer merely because his collective bargaining agreement provides for the termination of his services upon the happening of a condition subsequent and that condition does in fact occur. For example, if the collective bar-gaining agreement provides that the employer may automate a given de-partment and thereby dislocate several employees, the fact that the employ-ees collective bargaining agent has consented to such a condition will not render any employees subsequent un-employment for such cause voluntary. (4) Other similar conditions. Involun-tary separation directly resulting from other similar conditions includes, for ex-ample, involuntary separation from the employment of the employer resulting from cyclical, seasonal, or techno-logical causes. Some causes of involun-tary separation from the employment of the employer which are not similar to those enumerated in section 501(c)(17)(D)(i) are separation for dis-ciplinary reasons or separation because of age. (5) Subordinate sick and accident bene-fits. In general, a sick and accident ben-efit payment is an amount paid to an employee in the event of his illness or personal injury (whether or not such illness or injury results in the employ-ees separation from the service of his employer). In addition, the phrase sick and accident benefits includes amounts provided under the plan to reimburse an employee for amounts he expends because of the illness or injury of his spouse or a dependent (as defined in section 152). Sick and accident benefits may be paid by a trust described in sec-tion 501(c)(17) only if such benefits are subordinate to the separation pay-ments provided under the plan of which the trust forms a part. Whether the sick and accident benefits provided under a supplemental unemployment compensation benefit plan are subordi-nate to the separation benefits pro-vided under such plan is a question to be decided with regard to all the facts and circumstances. [T.D. 6972, 33 FR 12900, Sept. 12, 1968] 1.501(c)(17)2 General rules. (a) Supplemental unemployment com-pensation benefits. Supplemental unem-ployment compensation benefits as de-fined in section 501(c)(17)(D) and para-graph (b)(1) of 1.501(c)(17)1 may be paid in a lump sum or installments. Such benefits may be paid to an em-ployee who has, subsequent to his sepa-ration from the employment of the em-ployer, obtained other part-time, tem-porary, or permanent employment. Furthermore, such payments may be made in cash, services, or property. Thus, supplemental unemployment compensation benefits provided to in-voluntarily separated employees may include, for example, the following: Furnishing of medical care at an estab-lished clinic, furnishing of food, job training and schooling, and job coun-seling. If such benefits are furnished in services or property, the fair market value of the benefits must satisfy the requirements of section 501(c)(17)(A)(iii), relating to non-discrimination as to benefits. However, supplemental unemployment com-pensation benefits may be provided only to an employee and only under circumstances described in paragraph VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00047 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15038 26 CFR Ch. I (4113 Edition) 1.501(c)(17)2 (b)(1) of 1.501(c)(17)1. Thus, a trust de-scribed in section 501(c)(17) may not provide, for example, for the payment of a death, vacation, or retirement ben-efit. (b) Sick and accident benefits. If a trust described in section 501(c)(17) pro-vides for the payment of sick and acci-dent benefits, such benefits may only be provided for employees who are eli-gible for receipt of separation benefits under the plan of which the trust is a part. However, the sick and accident benefits need not be provided for all the employees who are eligible for re-ceipt of separation benefits, so long as the plan does not discriminate in favor of persons with respect to whom dis-crimination is proscribed in section 501(c)(17)(A) (ii) and (iii). Furthermore, the portion of the plan which provides for the payment of sick and accident benefits must satisfy the non-discrimination requirements of section 501(c)(17)(A) (ii) and (iii) without regard to the portion of the plan which pro-vides for the payment of benefits be-cause of involuntary separation. (c) Correlation with other plans. (1) In determining whether a plan meets the requirements of section 501(c)(17)(A) (ii) and (iii), any benefits provided under any other plan shall not be taken into consideration except in the particular instances enumerated in sec-tion 501(c)(17)(B) (i), (ii), and (iii). In general, these three exceptions permit a plan providing for the payment of supplemental unemployment com-pensation benefits to satisfy the non-discrimination requirements in section 501(c)(17)(A) (ii) and (iii) if the plan is able to satisfy such requirements when it is correlated with one or more of the plans described in section 501(c)(17)(B). (2) Under section 501(c)(17)(B)(i), a plan will not be considered discrimina-tory merely because the benefits under the plan which are first determined in a nondiscriminatory manner (within the meaning of section 501(c)(17)(A)) are then reduced by any sick, accident, or unemployment compensation bene-fits received under State or Federal law, or are reduced by a portion of these benefits if determined in a non-discriminatory manner. Under this ex-ception, a plan may, for example, sat-isfy the requirements of section 501(c)(17)(A)(iii) if it provides for the payment of an unemployment benefit and the amount of such benefit is de-termined as a percentage of the em-ployees compensation which is then reduced by any unemployment benefit which the employee receives under a State plan. In addition, a plan could provide for the reduction of such a plan benefit by a percentage of the State benefit. Furthermore, a plan may also satisfy the requirements of section 501(c)(17)(A) if it provides for the pay-ment to an employee of an amount which when added to any State unem-ployment benefit equals a percentage of the employees compensation. (3) Under section 501(c)(17)(B)(ii), a plan will not be considered discrimina-tory merely because the plan provides benefits only for employees who are not eligible to receive sick, accident, or unemployment compensation bene-fits under State or Federal law. In such a case, however, the benefits provided under the plan seeking to satisfy the requirements of section 501(c)(17) must be the same benefits, or a portion of the same benefits if determined in a nondiscriminatory manner, which such ineligible employees would receive under State or Federal law if they were eligible for such benefits. Under this exception, for example, an employer may establish a plan only for employ-ees who have exhausted their benefits under the State law, and, if the plan provides for such employees the same benefits which they would receive under the State plan, the State plan and the plan of the employer will be considered as one plan in determining whether the requirements relating to nondiscrimination in section 501(c)(17)(A) are satisfied. Furthermore, such a plan could also qualify even though it does not provide all of the benefits provided under the State plan. Thus, a plan could provide for the pay-ment of a reduced amount of the bene-fits, or for the payment of only certain of the types of benefits, provided by the State plan. For example, if the State plan provides for the payment of sick, accident, and separation benefits, the plan of the employer may provide for the payment of only separation bene-fits, or for the payment of an amount VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00048 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15039 Internal Revenue Service, Treasury 1.501(c)(17)2 equal to only one-half of the State pro-vided benefit. However, if a plan pro-vides benefits for employees who are not eligible to receive the benefits pro-vided under a State plan and such ben-efits are greater or of a different type than those under the State plan, the plan of the employer must satisfy the requirements of section 501(c)(17)(A) without regard to the benefits and cov-erage provided by the State plan. (4) Under section 501(c)(17)(B)(iii), a plan is not considered discriminatory merely because the plan provides bene-fits only for employees who are not eli-gible to receive benefits under another plan which satisfies the requirements of section 501(c)(17)(A) and which is funded solely by contributions of the employer. In such a case, the plan seeking to qualify under section 501(c)(17) must provide the same bene-fits, or a portion of such benefits if de-termined in a nondiscriminatory man-ner, as are provided for the employees under the plan funded solely by em-ployer contributions. Furthermore, this exception only applies if the em-ployees eligible to receive benefits under both plans would satisfy the re-quirements in section 501(c)(17)(A)(ii), relating to nondiscrimination as to coverage. The plan of the employer which is being correlated with the plan seeking to satisfy the requirements of section 501(c)(17) may be a plan which forms part of a voluntary employees beneficiary association described in section 501(c)(9), if such plan satisfies all the requirements of section 501(c)(17)(A). Under this exception, for example, if an employer has estab-lished a plan providing for the payment of supplemental unemployment com-pensation benefits for his hourly wage employees and such plan satisfies the requirements of section 501(c)(17)(A) (even though the plan forms part of a voluntary employees beneficiary asso-ciation described in section 501(c)(9)), the salaried employees of such em-ployee may establish a plan for them-selves, and, if such plan provides for the same benefits as the plan covering hourly-wage employees, both plans may be considered as one plan in deter-mining whether the plan covering the salaried employees satisfies the re-quirement that is be nondiscrim-inatory as to coverage. The foregoing example would also be applicable if the benefits provided for the salaried em-ployees were funded solely or in part by employer contributions. (d) Permanency of the plan. A plan providing for the payment of supple-mental unemployment compensation benefits contemplates a permanent as distinguished from a temporary pro-gram. Thus, although there may be re-served the right to change or terminate the plan, and to discontinue contribu-tions thereunder, the abandonment of the plan for any reason other than business necessity within a few years after it has taken effect will be evi-dence that the plan from its inception was not a bona fide program for the purpose of providing supplemental un-employment compensation benefits to employees. Whether or not a particular plan constitutes a permanent arrange-ment will be determined by all of the surrounding facts and circumstances. However, merely because a collective bargaining agreement provides that a plan may be modified at the termi-nation of such agreement, or that par-ticular provisions of the plan are sub-ject to renegotiation during the dura-tion of such agreement, does not nec-essarily imply that the plan is not a permanent arrangement. Moreover, the fact that the plan provides that the as-sets remaining in the trust after the satisfaction of all liabilities (including contingent liabilities) under the plan may be returned to the employer does not imply that the plan is not a perma-nent arrangement nor preclude the trust from qualifying under section 501(c)(17). (e) Portions of years. A plan must sat-isfy the requirements of section 501(c)(17) throughout the entire taxable year of the trust in order for the trust to be exempt for such year. However, section 501(c)(17)(C) provides that a plan will satisfy the nondiscrimination as to classification requirements of section 501(c)(17)(A) if on at least one day in each quarter of the taxable year of the trust it satisfies such require-ments. (f) Several trusts constituting one plan. Several trusts may be designated as constituting part of one plan which is intended to satisfy the requirements of VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00049 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15040 26 CFR Ch. I (4113 Edition) 1.501(c)(17)3 section 501(c)(17), in which case all of such trusts taken as a whole must meet the requirements of such section. The fact that a combination of trusts fails to satisfy the requirements of sec-tion 501(c)(17) as one plan does not pre-vent such of the trusts as satisfy the requirements of section 501(c)(17) from qualifying for exemption under that section. (g) Plan of several employers. A trust forming part of a plan of several em-ployers, or the employees of several employers, will be a supplemental un-employment benefit trust described in section 501(c)(17) if all the require-ments of that section are otherwise satisfied. (h) Investment of trust funds. No spe-cific limitations are provided in sec-tion 501(c)(17) with respect to invest-ments which may be made by the trustees of a trust qualifying under that section. Generally, the contribu-tions may be used by the trustees to purchase any investments permitted by the trust agreement to the extent al-lowed by local law. However, the tax- exempt status of the trust will be for-feited if the investments made by the trustees constitute prohibited trans-actions within the meaning of section 503. See section 503 and the regulations thereunder. In addition, such a trust will be subject to tax under section 511 with respect to any unrelated business taxable income (as defined in section 512) realized by it from its investments. See sections 511 to 515, inclusive, and the regulations thereunder. (i) Allocations. If a plan which pro-vides sick and accident benefits is fi-nanced solely by employer contribu-tions to the trust, and such sick and accident benefits are funded by pay-ment of premiums on an accident or health insurance policy (whether on a group or individual basis) or by con-tributions to a separate fund which pays such sick and accident benefits, the plan must specify that portion of the contributions to be used to fund such benefits. If a plan which is fi-nanced in whole or in part by employee contributions provides sick and acci-dent benefits, the plan must specify the portion, if any, of employee contribu-tions allocated to the cost of funding such benefits, and must allocate the cost of funding such benefits between employer contributions and employee contributions. (j) Required records and returns. Every trust described in section 501(c)(17) must maintain records indicating the amount of separation benefits and sick and accident benefits which have been provided to each employee. If a plan is financed, in whole or in part, by em-ployee contributions to the trust, the trust must maintain records indicating the amount of each employees total contributions allocable to separation benefits. In addition, every trust de-scribed in section 501(c)(17) which makes one or more payments totaling $600 or more in 1 year to an individual must file an annual information return in the manner described in paragraph (b)(1) of 1.60412. However, if the pay-ments from such trust are subject to income tax withholding under section 3402(o) and the regulations thereunder, the trust must file, in lieu of such an-nual information return, the returns of income tax withheld from wages re-quired by section 6011 and the regula-tions thereunder. In such cir-cumstances, the trust must also fur-nish the statements to the recipients of trust distributions required by section 6051 and the regulations thereunder. [T.D. 6972, 33 FR 12901, Sept. 12, 1968, as amended by T.D. 7068, 35 FR 17328, Nov. 11, 1970] 1.501(c)(17)3 Relation to other sec-tions of the Code. (a) Taxability of benefit distributions (1) Separation benefits. If the separation benefits described in section 501(c)(17)(D)(i) are funded entirely by employer contributions, then the full amount of any separation benefit pay-ment received by an employee is in-cludible in his gross income under sec-tion 61(a). If any such separation ben-efit is funded by both employer and employee contributions, or solely by employee contributions, the amount of any separation benefit payment which is includible in the gross income of the employee is the amount by which such distribution and any prior distribu-tions of such separation payments ex-ceeds the employees total contribu-tions to fund such separation benefits. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00050 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15041 Internal Revenue Service, Treasury 1.501(c)(18)1 (2) Sick and accident benefits. Any ben-efit payment received from the trust under the part of the plan, if any, which provides for the payment of sick and accident benefits must be included in gross income under section 61(a), un-less specifically excluded under section 104 or 105 and the regulations there-under. See section 105(b) and 1.1052 for benefit payments expended for med-ical care, benefit payments in excess of actual medical expenses, and benefit payments which an employee is enti-tled to receive irrespective of whether or not he incurs expenses for medical care. See section 213 and 1.2131(g) for benefit payments representing reim-bursement for medical expenses paid in prior years. See 1.501(c)(17)2(i) for the requirement that a trust described in section 501(c)(17) which receives em-ployee contributions must be part of a written plan which provides for the al-location of the cost of funding sick and accident benefits. (b) Exemption as a voluntary employ-ees beneficiary association. Section 501(c)(17)(E) contemplates that a trust forming part of a plan providing for the payment of supplemental unemploy-ment compensation benefits may, if it qualifies, apply for exemption from in-come tax under section 501(a) either as a voluntary employees beneficiary as-sociation described in section 501(c)(9) or as a trust described in section 501(c)(17). (c) Returns. A trust which is de-scribed in section 501(c)(17) and which is exempt from tax under section 501(a) must file a return in accordance with section 6033 and the regulations there-under. If such a trust realizes any unre-lated business taxable income, as de-fined in section 512, the trust is also re-quired to file a return with respect to such income. (d) Effective date. Section 501(c)(17) shall apply to taxable years beginning after December 31, 1959, and shall apply to supplemental unemployment benefit trusts regardless of when created or or-ganized. [T.D. 6972, 33 FR 12902, Sept. 12, 1968] 1.501(c)(18)1 Certain funded pension trusts. (a) In general. Organizations de-scribed in section 501(c)(18) are trusts created before June 25, 1959, forming part of a plan for the payment of bene-fits under a pension plan funded only by contributions of employees. In order to be exempt, such trusts must also meet the requirements set forth in sec-tion 501(c)(18) (A), (B), and (C), and in paragraph (b) of this section. (b) Requirements for qualification. A trust described in section 501(c)(18) must meet the following requirements: (1) Local law. The trust must be a valid, existing trust under local law, and must be evidenced by an executed written document. (2) Funding. The trust must be funded solely from contributions of employees who are members of the plan. For pur-poses of this section, the term contribu-tions of employees shall include earnings on, and gains derived from, the assets of the trust which were contributed by employees. (3) Creation before June 25, 1959(i) In general. The trust must have been cre-ated before June 25, 1959. A trust cre-ated before June 25, 1959 is described in section 501(c)(18) and this section even though changes in the makeup of the trust have occurred since that time so long as these are not fundamental changes in the character of the trust or in the character of the beneficiaries of the trust. Increases in the beneficiaries of the trust by the addition of employ-ees in the same or related industries, whether such additions are of individ-uals or of units (such as local units of a union) will generally not be consid-ered a fundamental change in the char-acter of the trust. A merger of a trust created after June 25, 1959 into a trust created before such date is not in itself a fundamental change in the character of the latter trust if the two trusts are for the benefit of employees of the same or related industries. (ii) Examples. The provisions of this subparagraph may be illustrated by the following examples: Example 1. Assume that trust C, for the benefit of members of participating locals of National Union X, was established in 1950 and adopted by 29 locals before June 25, 1959. The subsequent adoption of trust C by addi-tional locals of National Union X in 1962 will not constitute a fundamental change in the character of trust C, since such subsequent adoption is by employees in a related indus-try. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00051 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15042 26 CFR Ch. I (4113 Edition) 1.501(c)(19)1 Example 2. Assume the facts as stated in example 1, except that in 1965 National Union X merged with National Union Y, whose members are engaged in trades related to those engaged in by Xs members. Assume further that trust D, the employee funded pension plan and fund for employees of Y, was subsequently merged into trust C. The merger of trust D into trust C would not in itself constitute a fundamental change in the character of trust C, since both C and D are for the benefit of employees of related indus-tries. (4) Payment of benefits. The trust must provide solely for the payment of pension or retirement benefits to its beneficiaries. For purposes of this sec-tion, the term retirement benefits is in-tended to include customary and inci-dental benefits, such as death benefits within the limits permissible under section 401. (5) Diversion. The trust must be part of a plan which provides that, before the satisfaction of all liabilities to em-ployees covered by the plan, the corpus and income of the trust cannot (within the taxable year and at any time there-after) be used for, or diverted to, any purpose other than the providing of pension or retirement benefits. Pay-ment of expenses in connection with the administration of a plan providing pension or retirement benefits shall be considered a payment to provide such benefits and shall not affect the quali-fication of the trust. (6) Discrimination. The trust must be part of a plan whose eligibility condi-tions and benefits do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist of supervising the work of other employees, or highly com-pensated employees. See sections 401(a)(3)(B) and 401(a)(4) and 1.4013 and 1.4014. However, a plan is not dis-criminatory within the meaning of sec-tion 501(c)(18) merely because the bene-fits received under the plan bear a uni-form relationship to the total com-pensation, or the basic or regular rate of compensation, of the employees cov-ered by the plan. Accordingly, the ben-efits provided for highly paid employ-ees may be greater than the benefits provided for lower paid employees if the benefits are determined by ref-erence to their compensation; but, in such a case, the plan will not qualify if the benefits paid to the higher paid em-ployees are a larger portion of com-pensation than the benefits paid to lower paid employees. (7) Objective standards. The trust must be part of a plan which requires that benefits be determined according to objective standards. Thus, while a plan may provide similarly situated employees with benefits which differ in kind and amount, these benefits may not be determined solely in the discre-tion of the trustees. (c) Effective date. The provisions of section 501(c)(18) and this section shall apply with respect to taxable years be-ginning after December 31, 1969. [T.D. 7172, 37 FR 5618, Mar. 17, 1972] 1.501(c)(19)1 War veterans organiza-tions. (a) In general. (1) For taxable years beginning after December 31, 1969, a veterans post or organization which is organized in the United States or any of its possessions may be exempt as an organization described in section 501(c)(19) if the requirements of para-graphs (b) and (c) of this section are met and if no part of its net earnings inures to the benefit of any private shareholder or individual. Paragraph (b) of this section contains the mem-bership requirements such a post or or-ganization must meet in order to qual-ify under section 501(c)(19). Paragraph (c) of this section outlines the pur-poses, at least one of which such a post or organization must have in order to so qualify. (2) In addition, an auxiliary unit or society described in paragraph (d) of this section of such a veterans post or organization and a trust or foundation described in paragraph (e) of this sec-tion for such post or organization may be exempt as an organization described in section 501(c)(19). (b) Membership requirements. (1) In order to be described in section 501(c)(19) under paragraph (a)(1) of this section, an organization must meet the membership requirements of section 501(c)(19)(B) and this paragraph. There are two requirements that must be met under this paragraph. The first require-ment is that at least 75 percent of the members of the organization must be VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00052 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15043 Internal Revenue Service, Treasury 1.501(c)(19)1 war veterans. For purposes of this sec-tion the term war veterans means per-sons, whether or not present members of the United States Armed Forces, who have served in the Armed Forces of the United States during a period of war (including the Korean and Vietnam conflicts). (2) The second requirement of this paragraph is that at least 97.5 percent of all members of the organization must be described in one or more of the following categories: (i) War veterans, (ii) Present or former members of the United States Armed Forces, (iii) Cadets (including only students in college or university ROTC pro-grams or at Armed Services acad-emies), or (iv) Spouses, widows, or widowers of individuals referred to in paragraph (b)(2) (i), (ii) or (iii) of this section. (c) Exempt purposes. In addition to the requirements of paragraphs (a)(1) and (b) of this section, in order to be de-scribed in section 501(c)(19) under para-graph (a)(1) of this section an organiza-tion must be operated exclusively for one or more of the following purposes: (1) To promote the social welfare of the community as defined in 1.501(c)(4)1(a)(2). (2) To assist disabled and needy war veterans and members of the United States Armed Forces and their depend-ents, and the widows and orphans of de-ceased veterans, (3) To provide entertainment, care, and assistance to hospitalized veterans or members of the Armed Forces of the United States, (4) To carry on programs to perpet-uate the memory of deceased veterans and members of the Armed Forces and to comfort their survivors, (5) To conduct programs for religious, charitable, scientific, literary, or edu-cational purposes, (6) To sponsor or participate in ac-tivities of a patriotic nature, (7) To provide insurance benefits for their members or dependents of their members or both, or (8) To provide social and recreational activities for their members. (d) Auxiliary units or societies for war veterans organizations. A unit or society may be exempt as an organization de-scribed in section 501(c)(19) and para-graph (a)(2) of this section if it is an auxiliary unit or society of a post or organization of war veterans described in paragraph (a)(1) of this section. A unit or society is an auxiliary unit or society or such a post or organization if it meets the following requirements: (1) It is affiliated with, and organized in accordance with, the bylaws and reg-ulations formulated by an organization described in paragraph (a)(1) of this section, (2) At least 75 percent of its members are either war veterans, or spouses of war veterans, or are related to a war veteran within two degrees of consan-guinity (i.e., grandparent, brother, sis-ter, grandchild, represent the most dis-tant allowable relationships), (3) All of its members are either members of an organization described in paragraph (a)(1) of this section, or spouses of a member of such an organi-zation or are related to a member of such an organization, within two de-grees of consanguinity, and (4) No part of its net earnings inures to the benefit of any private share-holder or individual. (e) Trusts or foundations. A trust or foundation may be exempt as an orga-nization described in section 501(c)(19) and paragraph (a)(2) of this section if it is a trust or foundation for a post or or-ganization of war veterans described in paragraph (a)(1) of this section. A trust or foundation is a trust or foundation for such a post or organization if it meets the following requirements: (1) The trust or foundation is in ex-istence under local law and, if orga-nized for charitable purposes, has a dis-solution provision described in 1.501(c)(3)1(b)(4). (2) The corpus or income cannot be diverted or used other than for the funding of a post or organization of war veterans described in paragraph (a)(1) of this section, for section 170(c)(4) pur-poses, or as an insurance set aside (as defined in 1.512(a)4(b)). (3) The trust income is not unreason-ably accumulated and, if the trust or foundation is not an insurance set aside, a substantial portion of the in-come is in fact distributed to such post or organization or for section 170(c)(4) charitable purposes, and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00053 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15044 26 CFR Ch. I (4113 Edition) 1.501(c)(21)1 (4) It is organized exclusively for one or more of those purposes enumerated in paragraph (c) of this section. [T.D. 7438, 41 FR 44392, Oct. 8, 1976] 1.501(c)(21)1 Black lung trustscer-tain terms. (a) Created or organized in the United States. A trust is not created or orga-nized in the United States unless it is maintained at all times as a domestic trust in the United States. For this purpose, section 7701(a)(9) limits the term United States to the District of Co-lumbia and States of the United States. (b) Insurance company. The term in-surance company means an insurance, surety, bonding or other company whose liability for the kinds of claims to which section 501(c)(21)(A)(i) applies is as an insurer or guarantor of the li-abilities of another. (c) Black Lung Acts. The term Black Lung Acts includes any State law pro-viding compensation for disability or death due to pneumoconiosis even though the State law compensates for other kinds of injuries. In such a case, section 501(c)(21) applies only to the ex-tent that the liability is attributable to disability or death due to pneumo-coniosis. For this purpose, the term pneumoconiosis has the same meaning as it has under federal law. See 30 U.S.C. 902. (d) Insurance exclusively covering such liability. The term insurance exclusively covering such liability includes insur-ance that covers risk for liabilities in addition to the liabilities to which sec-tion 501(c)(21)(A)(i) applies. In such a case, payment for premiums may be made from the trust only to the extent of that portion of the premiums that has been separately allocated and stat-ed by the insurer as attributable solely to coverage of the liabilities to which section 501(c)(21)(A)(i) applies. (e) Administrative and other incidental expenses. The term administrative and other incidental expenses means expendi-tures that are appropriate and helpful to the trust making them in carrying out the purposes for which its assets may be used under section 501(c)(21)(B). The term includes any exicse tax im-posed on the trust under section 4952 (relating to taxes on taxable expendi-tures) and reasonable expenses, such as legal expenses, incurred by the trust in connection with an assertion against the trust of liability for a taxable ex-penditure. The term does not include an excise tax imposed on the trustee or on other disqualified persons under sec-tion 4951 (relating to taxes on self-deal-ing) or under section 4953 (relating to tax on excess contributions to black lung benefit trusts) or any expenses in-curred in connection with the assertion of these taxes other than expenses that are treated as part of reasonable com-pensation under section 4951(d)(2)(C). See 53.4941 (d)2(f)(3) and (d)3(c) for interpretations of similar provisions under section 4941(d)(2)(E), relating to reasonable compensation for private foundation disqualified persons. (f) Public debt securities of the United States. The term public debt securities of the United States means obligations that are taken into consideration for purposes of the public debt limit. See, for example 31 U.S.C. 757b. (g) Obligations of a State or local gov-ernment. The term obligations of a State or local government means the obliga-tions of a State or local governmental unit the interest on which is exempt from tax under section 103(a). See 1.1031(a). (h) Time or demand deposits. The term time or demand deposits includes check-ing accounts, savings accounts, certifi-cates of deposit or other time or de-mand deposits. The term does not in-clude common or collective trust funds such as a common trust fund as defined in section 584. [44 FR 52197, Sept. 7, 1979] 1.501(c)(21)2 Sametrust instru-ment. As trust does not meet the require-ments of section 501(c)(21) if it is not established and maintained pursuant to a written instrument. The trust in-strument must definitely and affirma-tively prohibit a diversion or use of trust assets that is not permitted under section 501(c)(21)(B) or section 4953(c), whether by operation or nat-ural termination of the trust, by power of revocation or amendment by the happening of a contingency by collat-eral arrangement, or by any other means. No particular form for the trust VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00054 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15045 Internal Revenue Service, Treasury 1.501(e)1 instrument is required. A trust may meet the requirements of section 501(c)921) although the trust instru-ment fails to contain provisions the ef-fects of which are to prohibit acts that are subject to section 4951 (relating to taxes on self-dealing), section 4952 (re-lating to taxes on taxable expendi-tures) or the retention of contributions subject to section 4953 (relating to tax on excess contributions to black lung benefit trusts). [44 FR 52197, Sept. 7, 1979] 1.501(c)(29)1T COOP Health Insur-ance Issuers (temporary). (a) Organizations must notify the Com-missioner that they are applying for rec-ognition of section 501(c)(29) status. An organization will not be treated as de-scribed in section 501(c)(29) unless the organization has given notice to the Commissioner that it is applying for recognition as an organization de-scribed in section 501(c)(29) in the man-ner prescribed by the Commissioner in published guidance. (b) Effective date of recognition of sec-tion 501(c)(29) status. An organization may be recognized as an organization described in section 501(c)(29) as of a date prior to the date of the notice re-quired by paragraph (a) of this section if the notice is given in the manner and within the time prescribed by the Com-missioner and the organizations pur-poses and activities prior to giving such notice were consistent with the requirements for exempt status under section 501(c)(29). However, an organi-zation may not be recognized as an or-ganization described in section 501(c)(29) before the later of its forma-tion or March 23, 2010. (c) Effective/applicability date. Para-graphs (a) and (b) of this section are ef-fective on February 7, 2012. (d) Expiration date. The applicability of this section expires on February 6, 2015. [T.D. 9574, 77 FR 6006, Feb. 7, 2012] 1.501(d)1 Religious and apostolic as-sociations or corporations. (a) Religious or apostolic associa-tions or corporations are described in section 501(d) and are exempt from tax-ation under section 501(a) if they have a common treasury or community treasury, even though they engage in business for the common benefit of the members, provided each of the mem-bers includes (at the time of filing his return) in his gross income his entire pro rata share, whether distributed or not, of the net income of the associa-tion or corporation for the taxable year of the association or corporation end-ing with or during his taxable year. Any amount so included in the gross income of a member shall be treated as a dividend received. (b) For annual return requirements of organizations described in section 501(d), see section 6033 and paragraph (a)(5) of 1.60331. 1.501(e)1 Cooperative hospital serv-ice organizations. (a) General rule. Section 501(e) is the exclusive and controlling section under which a cooperative hospital service organization can qualify as a chari-table organization. A cooperative hos-pital service organization which meets the requirements of section 501(e) and this section shall be treated as an orga-nization described in section 501(c)(3), exempt from taxation under section 501(a), and referred to in section 170(b)(1)(A) (iii) (relating to percentage limitations on charitable contribu-tions). In order to qualify for tax ex-empt status, a cooperative hospital service organization must (1) Be organized and operated on a co-operative basis, (2) Perform, on a centralized basis, only one or more specifically enumer-ated services which, if performed di-rectly by a tax exempt hospital, would constitute activities in the exercise or performance of the purpose or function constituting the basis for its exemp-tion, and (3) Perform such service or services solely for two or more patron-hospitals as described in paragraph (d) of this section. (b) Organized and operated on a coop-erative basis(1) In general. In order to meet the requirements of section 501(e), the organization must be orga-nized and operated on a cooperative basis (whether or not under a specific VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00055 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15046 26 CFR Ch. I (4113 Edition) 1.501(e)1 statute on cooperatives) and must allo-cate or pay all of its net earnings with-in 812 months after the close of the tax-able year to its patron-hospitals on the basis of the percentage of its services performed for each patron. To allocate its net earnings to its patron-hospitals, the organization must make appro-priate bookkeeping entries and provide timely written notice to each patron- hospital disclosing to the patron-hos-pital the amount allocated to it on the books of the organization. For the rec-ordkeeping requirements of a section 501(e) organization, see 1.5211(a)(1). (2) Percentage of services defined. The percentage of services performed for each patron-hospital may be deter-mined on the basis of either the value or the quantity of the services provided by the organization to the patron-hos-pital, provided such basis is realistic in terms of the actual cost of the services to the organization. (3) Retention of net earnings. Exemp-tion will not be denied a cooperative hospital service organization solely be-cause the organization, instead of pay-ing all net earnings to its patron-hos-pitals, retains an amount for such pur-poses as retiring indebtedness, expand-ing the services of the organization, or for any other necessary purpose and al-locates such amounts to its patrons. However, such funds may not be accu-mulated beyond the reasonably antici-pated needs of the organization. See, 1.5371(b). Whether there is an im-proper accumulation of funds depends upon the particular circumstances of each case. Moreover, where an organi-zation retains net earnings for nec-essary purposes, the organizations records must show each patrons rights and interests in the funds retained. For purposes of this paragraph, the term net earnings does not include capital contributions to the organization and such contributions need not satisfy the allocation or payment requirements. (4) Nonpatronage and other income. An organization described in section 501(e) may, in addition to net earnings, re-ceive membership dues and related membership assessment fees, gifts, grants and income from nonpatronage sources such as investment of retained earnings. However, such an organiza-tion cannot be exempt if it engages in any business other than that of pro-viding the specified services, described in paragraph (c), for the specified pa-tron-hospitals, described in paragraph (d). Thus, an organization described in section 501(e) generally cannot have unrelated business taxable income as defined in section 512, although it may earn certain interest, annuities, royal-ties, and rents which are excluded from unrelated business taxable income be-cause of the modifications contained in sections 512(b) (1), (2) or (3). An organi-zation described in section 501(e) may, however, have debt-financed income which is treated as unrelated business taxable income solely because of the applicability of section 514. In addition, exempt status under section 501(e) will not be affected where rent from per-sonal property leased with real prop-erty is treated as unrelated business taxable income under section 512(b)(3)(A)(ii) solely because the rent attributable to the personal property is more than incidental or under section 512(b)(3)(B)(i) solely because the rent attributable to the personal property exceeds 50 percent of the total rent re-ceived or accrued under the lease. Ex-emption will not be affected solely be-cause the determination of the amount of rent depends in whole or in part on the income or profits derived from the property leased. See, section 512(b)(3)(B)(ii). An organization de-scribed in section 501(e) may also de-rive nonpatronage income from sources that are incidental to the conduct of its exempt purposes or functions. For example, income derived from the oper-ation of a cafeteria or vending ma-chines primarily for the convenience of its employees or the disposition of by- products in substantially the same state they were in on completion of the exempt function (e.g., the sale of silver waste produced in the processing of x- ray film) will not be considered unre-lated business taxable income. See, section 513(a)(2) and 1.5131(d)(4)(ii). The nonpatronage and other income permitted under this subparagraph (4) must be allocated or paid as provided in subparagraph (1) or retained as pro-vided in subparagraph (3). (5) Stock ownership(i) Capital stock of organization. An organization does not meet the requirements of section 501(e) VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00056 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15047 Internal Revenue Service, Treasury 1.501(e)1 unless all of the organizations out-standing capital stock, if there is such stock, is held solely by its patron-hos-pitals. However, no amount may be paid as dividends on the capital stock of the organization. For purposes of the preceding sentence, the term capital stock includes common stock (whether voting or nonvoting), preferred stock, or any other form evidencing a propri-etary interest in the organization. (ii) Stock ownership as a condition for obtaining credit. If by statutory require-ment a cooperative hospital service or-ganization must be a shareholder in a United States or state chartered cor-poration as a condition for obtaining credit from that corporate-lender, the ownership of shares and the payment of dividends thereon will not for such rea-son be a basis for the denial of exemp-tion to the organization. See, e.g., Na-tional Consumer Cooperative Bank, 12 U.S.C. 3001 et seq. (c) Scope of services(1) Permissible services. An organization meets the re-quirements of section 501(e) only if the organization performs, on a centralized basis, one or more of the following services and only such services: data processing, purchasing (including the purchasing and dispensing of drugs and pharmaceuticals to patron-hospitals), warehousing, billing and collection, food, clinical (including radiology), in-dustrial engineering (including the in-stallation, maintenance and repair of biomedical and similar equipment), laboratory, printing, communications, record center, and personnel (including recruitment, selection, testing, train-ing, education and placement of per-sonnel) services. An organization is not described in section 501(e) if, in addi-tion to or instead of one or more of these specified services, the organiza-tion performs any other service (other than services referred to under para-graph (b)(4) that are incidental to the conduct of exempt purposes or func-tions). (2) Illustration. The provisions of this subparagraph may be illustrated by the following example. Example. An organization performs indus-trial engineering services on a cooperative basis solely for patron-hospitals each of which is an organization described in section 501(c)(3) and exempt from taxation under sec-tion 501(a). However, in addition to this serv-ice, the organization operates laundry serv-ices for its patron-hospitals. This coopera-tive organization does not meet the require-ments of this paragraph because it performs laundry services not specified in this para-graph. (d) Patron-hospitals(1) Defined. Sec-tion 501(e) only applies if the organiza-tion performs its services solely for two or more patron-hospitals each of which is (i) An organization described in sec-tion 501(c)(3) which is exempt from tax-ation under section 501(a), (ii) A constituent part of an organiza-tion described in section 501(c)(3) which is exempt from taxation under section 501(a) and which, if organized and oper-ated as a separate entity, would con-stitute an organization described in section 501(c)(3), or (iii) Owned and operated by the United States, a State, the District of Columbia, or a possession of the United States, or a political subdivision or an agency or instrumentality of any of the foregoing. (2) Business with nonvoting patron-hos-pitals. Exemption will not be denied a cooperative hospital service organiza-tion solely because the organization (whether organized on a stock or mem-bership basis) transacts business with patron-hospitals which do not have voting rights in the organization and therefore do not participate in the de-cisions affecting the operation of the organization. Where the organization has both patron-hospitals with voting rights and patron-hospitals without such rights, the organization must pro-vide at least 50 percent of its services to patron-hospitals with voting rights in the organization. Thus, the percent-age of services provided to nonvoting patrons may not exceed the percentage of such services provided to voting pa-trons. A patron-hospital will be deemed to have voting rights in the coopera-tive hospital service organization if the patron-hospital may vote directly on matters affecting the operation of the organization or if the patron-hospital may vote in the election of cooperative board members. Notwithstanding that an organization may have both voting and nonvoting patron-hospitals, pa-tronage refunds must nevertheless be VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00057 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15048 26 CFR Ch. I (4113 Edition) 1.501(h)1 allocated or paid to all patron-hos-pitals solely on the basis specified in paragraph (b) of this section. (3) Services to other organizations. An organization does not meet the require-ments of section 501(e) if, in addition to performing services for patron-hos-pitals (entities described in subdivi-sions (i), (ii) or (iii) of subparagraph (1)), the organization performs any service for any other organization. For example, a cooperative hospital service organization is not exempt if it per-forms services for convalescent homes for children or the aged, vocational training facilities for the handicapped, educational institutions which do not provide hospital care in their facilities, and proprietary hospitals. However, the provision of the specified services between or among cooperative hospital service organizations meeting the re-quirements of section 501(e) and this section is permissible. Also permissible is the provision of the specified serv-ices to entities which are not patron- hospitals, but only if such services are de minimis and are mandated by a gov-ernmental unit as, for example, a con-dition for licensing. (e) Effective dates. An organization, other than an organization performing clinical services, may meet the re-quirements of section 501(e) and be a tax exempt organization for taxable years ending after June 28, 1968. An or-ganization performing clinical services may meet the requirements of section 501(e) and be a tax exempt organization for taxable years ending after Decem-ber 31, 1976. However, pursuant to the authority contained in section 7805(b) of the Internal Revenue Code, these regulations shall not become effective with respect to an organization which has received a ruling or determination letter from the Internal Revenue Serv-ice recognizing its exemption under section 501(e) until January 2, 1987. [T.D. 8100, 51 FR 31615, Sept. 4, 1986; 51 FR 33593, Sept. 22, 1986] 1.501(h)1 Application of the expendi-ture test to expenditures to influ-ence legislation; introduction. (a) Scope. (1) There are certain re-quirements an organization must meet in order to be a charity described in sec-tion 501(c)(3). Among other things, sec-tion 501(c)(3) states that no substan-tial part of the activities of [a charity may consist of] carrying on propa-ganda, or otherwise attempting to in-fluence legislation, (except as other-wise provided in subsection (h)). This requirement is called the substantial part test. (2) Under section 501(h), many public charities may elect the expenditure test as a substitute for the substantial part test. The expenditure test is described in section 501(h) and this 1.501(h). A public charity is any charity that is not a private foundation under section 509(a). (Unlike a public charity, a pri-vate foundation may not make any lob-bying expenditures: If a private founda-tion does make a lobbying expenditure, it is subject to an excise tax under sec-tion 4945). Section 1.501(h)2 lists which public charities are eligible to make the expenditure test election. Section 1.501(h)2 also provides information about how a public charity makes and revokes the election to be covered by the expenditure test. (3) A public charity that makes the election may make lobbying expendi-tures within specified dollar limits. If an electing public charitys lobbying expenditures are within the dollar lim-its determined under section 4911(c), the electing public charity will not owe tax under section 4911 nor will it lose its tax exempt status as a charity by virtue of section 501(h). If, however, that electing public charitys lobbying expenditures exceed its section 4911 lobbying limit, the organization is sub-ject to an excise tax on the excess lob-bying expenditures. Further, under sec-tion 501(h), if an electing public charitys lobbying expenditures nor-mally are more than 150 percent of its section 4911 lobbying limit, the organi-zation will cease to be a charity de-scribed in section 501(c)(3). (4) A public charity that elects the expenditure test may nevertheless lose its tax exempt status if it is an action organization under 1.501(c)(3) 1(c)(3)(iii) or (iv). A public charity that does not elect the expenditure test re-mains subject to the substantial part test. The substantial part test is ap-plied without regard to the provisions of section 501(h) and 4911 and the re-lated regulations. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00058 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15049 Internal Revenue Service, Treasury 1.501(h)2 (b) Effective date. The provisions of 1.501(h)1 through 1.501(h)3, are ef-fective for taxable years beginning after August 31, 1990. An election made before August 31, 1990, under the provi-sions of 7.0(c)(4) or the instructions to Form 5768, will be effective under these regulations without again filing Form 5768. [T.D. 8308, 55 FR 35588, Aug. 31, 1990] 1.501(h)2 Electing the expenditure test. (a) In general. The election to be gov-erned by section 501(h) may be made by an eligible organization (as described in paragraph (b) of this section) for any taxable year of the organization begin-ning after December 31, 1976, other than the first taxable year for which a voluntary revocation of the election is effective (see paragraph (d) of this sec-tion). The election is made by filing a completed Form 5768, Election/Revoca-tion of Election by an Eligible Section 501(c)(3) Organization to Make Expend-itures to Influence Legislation, with the appropriate Internal Revenue Serv-ice Center listed on that form. Under section 501(h)(6), the election is effec-tive with the beginning of the taxable year in which the form is filed. For ex-ample, if an eligible organization whose taxable year is the calendar year files Form 5768 on December 31, 1979, the organization is governed by section 501(h) for its taxable year beginning January 1, 1979. Once made, the ex-penditure test election is effective (without again filing Form 5768) for each succeeding taxable year for which the organization is an eligible organi-zation and which begins before a notice of revocation is filed under paragraph (d) of this section. (b) Organizations eligible to elect the expenditure test(1) In general. For pur-poses of section 501(h) and the regula-tions thereunder, an organization is an eligible organization for a taxable year if, for that taxable year, it is (i) Described in section 501(c)(3) (de-termined, in any year for which an election is in effect, without regard to the substantial part test of section 501(c)(3)), (ii) Described in section 501(h)(4) and paragraph (b)(2) of this section, and (iii) Not a disqualified organization described in section 501(h)(5) and para-graph (b)(3) of this section. (2) Certain organizations listed. An or-ganization is described in section 501(h)(4) and this paragraph (b)(2) if it is an organization described in (i) Section 170(b)(1)(A)(ii) (relating to educational institutions), (ii) Section 170(b)(1)(A)(iii) (relating to hospitals and medical research orga-nizations), (iii) Section 170(b)(1)(A)(iv) (relating to organizations supporting govern-ment schools), (iv) Section 170(b)(1)(A)(vi) (relating to organizations publicly supported by charitable contributions), (v) Section 509(a)(2) (relating to orga-nizations publicly supported by admis-sions, sales, etc.), or (vi) Section 509(a)(3) (relating to or-ganizations supporting public char-ities), except that for purposes of this paragraph (b)(2), section 509(a)(3) shall be applied without regard to the last sentence of section 509(a). (3) Disqualified organizations. An orga-nization is a disqualified organization described in section 501(h)(5) and this paragraph (b)(3) if the organization is (i) Described in section 170(b)(1)(A)(i) (relating to churches), (ii) An integrated auxiliary of a church or of a convention or associa-tion of churches see ( 1.60332(g)(5)), or (iii) Described in section 501(c)(3) and affiliated (within the meaning of 56.49117) with one or more organiza-tions described in paragraph (b)(3) (i) or (ii) of this section. (4) Other organizations ineligible to elect. Under section 501(h)(4), certain organizations, although not disquali-fied organizations, are not eligible to elect the expenditure test. For exam-ple, organizations described in section 509(a)(4) are not listed in section 501(h)(4) and therefore are not eligible to elect. Similarly, private foundations (within the meaning of section 509(a)) are not eligible to elect. For the treat-ment of expenditures by a private foun-dation for the purpose of carrying on propaganda, or otherwise attempting, to influence legislation, see 53.49452. (c) New organizations. A newly cre-ated organization may submit Form 5768 to elect the expenditure test under VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00059 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15050 26 CFR Ch. I (4113 Edition) 1.501(h)3 section 501(h) before it is determined to be an eligible organization and may submit Form 5768 at the time it sub-mits its application for recognition of exemption (Form 1023). If the newly created organization is determined to be an eligible organization, the elec-tion will be effective under the provi-sions of paragraph (a) of this section, that is, with the beginning of the tax-able year in which the Form 5768 is filed by the eligible organization. How-ever, if a newly created organization is determined by the Service not to be an eligible organization, the organiza-tions election will not be effective and the substantial part test will apply from the effective date of its section 501(c)(3) classification. (d) Voluntary revocation of expenditure test election(1) Revocation effective. An organization may voluntarily revoke an expenditure test election by filing a notice of voluntary revocation with the appropriate Internal Revenue Service Center listed on Form 5768. Under sec-tion 501(h)(6)(B), a voluntary revoca-tion is effective with the beginning of the first taxable year after the taxable year in which the notice is filed. If an organization voluntarily revokes its election, the substantial part test of section 501(c)(3) will apply with respect to the organizations activities in at-tempting to influence legislation be-ginning with the taxable year for which the voluntary revocation is ef-fective. (2) Re-election of expenditure test. If an organizations expenditure test elec-tion is voluntarily revoked, the organi-zation may again make the expendi-ture test election, effective no earlier than for the taxable year following the first taxable year for which the revoca-tion is effective. (3) Example. X, an organization whose taxable year is the calendar year, plans to voluntarily revoke its expenditure test election effective beginning with its taxable year 1985. X must file its no-tice of voluntary revocation on Form 5768 after December 31, 1983, and before January 1, 1985. If X files a notice of voluntary revocation on December 31, 1984, the revocation is effective begin-ning with its taxable year 1985. The or-ganization may again elect the expend-iture test by filing Form 5768. Under paragraph (d)(2) of this section, the election may not be made for taxable year 1985. Under paragraph (a) of this section, a new expenditure test elec-tion will be effective for taxable years beginning with taxable year 1986, if the Form 5768 is filed after December 31, 1985, and before January 1, 1987. (e) Involuntary revocation of expendi-ture test election. If, while an election by an eligible organization is in effect, the organization ceases to be an eligi-ble organization, its election is auto-matically revoked. The revocation is effective with the beginning of the first full taxable year for which it is deter-mined that the organization is not an eligible organization. If an organiza-tions expenditure test election is in-voluntarily revoked under this para-graph (e) but the organization con-tinues to be described in section 501(c)(3), the substantial part test of section 501(c)(3) will apply with respect to the organizations activities in at-tempting to influence legislation be-ginning with the first taxable year for which the involuntary revocation is ef-fective. (f) Supersession. This section super-sedes 7.0(c)(4) of the Temporary In-come Tax Regulations under the Tax Reform Act of 1976, effective August 31, 1990. [T.D. 8308, 55 FR 35588, Aug. 31, 1990] 1.501(h)3 Lobbying or grass roots expenditures normally in excess of ceiling amount. (a) Scope. This section provides rules under section 501(h) for determining whether an organization that has elect-ed the expenditure test and that is not a member of an affiliated group of or-ganizations (as defined in 56.49117(e)) either normally makes lobbying ex-penditures in excess of its lobbying ceiling amount or normally makes grass roots expenditures in excess of its grass roots ceiling amount. Under sec-tion 501(h) and this section, an organi-zation that has elected the expenditure test and that normally makes expendi-tures in excess of the corresponding ceiling amount will cease to be exempt from tax under section 501(a) as an or-ganization described in section 501(c)(3). For similar rules relating to VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00060 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15051 Internal Revenue Service, Treasury 1.501(h)3 members of an affiliated group of orga-nizations, see 56.49119. (b) Loss of exemption(1) In general. Under section 501(h)(1), an organization that has elected the expenditure test shall be denied exemption from tax-ation under section 501(a) as an organi-zation described in section 501(c)(3) for the taxable year following a deter-mination year if (i) The sum of the organizations lob-bying expenditures for the base years exceeds 150 percent of the sum of its lobbying nontaxable amounts for the base years, or (ii) The sum of the orga-nizations grass roots expenditures for its base years exceeds 150 percent of the sum of its grass roots nontaxable amounts for the base years. The organization thereafter shall not be exempt from tax under section 501(a) as an organization described in section 501(c)(3) unless, pursuant to paragraph (d) of this section, the organization re-applies for recognition of exemption and is recognized as exempt. (2) Special exception for organizations first election. For the first, second, or third consecutive determination year for which an organizations first ex-penditure test election is in effect, no determination is required under para-graph (b)(1) of this section, and the or-ganization will not be denied exemp-tion from tax by reason of section 501(h) and this section if, taking into account as base years only those years for which the expenditure test election is in effect (i) The sum of the organizations lob-bying expenditures for such base years does not exceed 150 percent of the sum of its lobbying nontaxable amounts for the same base years, and (ii) The sum of the organizations grass roots expenditure for those base years does not exceed 150 percent of the sum of its grass roots nontaxable amounts for such base years. If an or-ganization does not satisfy the require-ments of this paragraph (b)(2), para-graph (b)(1) of this section will apply. (c) Definitions. For purposes of this section (1) The term lobbying expenditures means lobbying expenditures as defined in section 4911(c)(1) or section 4911(f)(4)(A) and 56.49112(a). (2) The term lobbying nontaxable amount is defined in 56.49111(c)(1). (3) An organizations lobbying ceiling amount is 150 percent of the organiza-tions lobbying nontaxable amount for a taxable year. (4) The term grass roots expenditures means expenditures for grass roots lob-bying communications as defined in section 4911(c)(3) or section 4911(f)(4)(A) and 56.49112 and 56.49113. (5) The term grass roots nontaxable amount is defined in 56.49111(c)(2). (6) An organizations grass roots ceil-ing amount is 150 percent of the organi-zations grass roots nontaxable amount for a taxable year. (7) In general, the term base years means the determination year and the three taxable years immediately pre-ceding the determination year. The base years, however, do not include any taxable year preceding the taxable year for which the organization is first treated as described in section 501(c)(3). (8) A taxable year is a determination year if it is a year for which the ex-penditure test election is in effect, other than the taxable year for which the organization is first treated as de-scribed in section 501(c)(3). (d) Reapplication for recognition of ex-emption(1) Time of application. An or-ganization that is denied exemption from taxation under section 501(a) by reason of section 501(h) and this section may apply on Form 1023 for recognition of exemption as an organization de-scribed in section 501(c)(3) for any tax-able year following the first taxable year for which exemption is so denied. See paragraphs (d)(2) and (d)(3) of this section for material to be included with an application described in the preceding sentence. (2) Section 501(h) calculation. An appli-cation described in paragraph (d)(1) of this section must demonstrate that the organization would not be denied ex-emption from taxation under section 501(a) by reason of section 501(h) if the expenditure test election has been in effect for all of its last taxable year ending before the application is made by providing the calculations, de-scribed either in paragraphs (b)(1) (i) and (ii) of this section or in 56.4911 9(b), that would have applied to the or-ganization for that year. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00061 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15052 26 CFR Ch. I (4113 Edition) 1.501(h)3 (3) Operations not disqualifying. An ap-plication described in paragraph (d)(1) of this section must include informa-tion that demonstrates to the satisfac-tion of the Commissioner that the or-ganization will not knowingly operate in a manner that would disqualify the organization for tax exemption under section 501(c)(3) by reason of attempt-ing to influence legislation. (4) Reelection of expenditure test. If an organization is denied exemption from tax for a taxable year by reason of sec-tion 501(h) and this section, and there-after is again recognized as an organi-zation described in section 501(c)(3) pursuant to this paragraph (d), it may again elect the expenditure test under section 501(h) in accordance with 1.501(h)2(a). (e) Examples. The provisions of this section are illustrated by the following examples, which also illustrate the op-eration of the tax imposed by section 4911. Example 1. (1) The following table contains information used in this example concerning organization X. Year Exempt pur-pose expendi-tures (EPE) Calculation Lobbying Nontaxable amount (LNTA) Lobbying ex-penditures (LE) 1979 ............. $400,000 (20% of $400,000=) ................................................................ $80,000 $100,000 1980 ............. 300,000 (20% of $300,000=) ................................................................ 60,000 100,000 1981 ............. 600,000 (20% of $500,000+15% of $100,000=) .................................. 115,000 120,000 1982 ............. 500,000 (20% of $500,000=) ................................................................ 100,000 100,000 Totals ....... 1,800,000 .................................................................................................. 355,000 420,000 (2) Organization X, whose taxable year is the calendar year, was organized in 1971. X first made the expenditure test election under section 501(h) effective for taxable years beginning with 1979 and has not re-voked the election. None of Xs lobbying ex-penditures for its taxable years 1979 through 1982 are grass roots expenditures. Under sec-tion 4911(a) and 56.49111(a), X must deter-mine for each year for which the expenditure test election is effective whether it is liable for the 25 percent excise tax imposed by sec-tion 4911(a) on excess lobbying expenditures. X is liable for this tax for each of its taxable years 1979, 1980, and 1981, because in each year its lobbying expenditures exceeded its lobbying nontaxable amount for the year. For 1979, the tax imposed by section 4911(a) is $5,000 {25%($100,000$80,000)=$5,000}. For 1980, the tax is $10,000. For 1981, the tax is $1,250. (3) The taxable years 1979 through 1981 are all determination years under paragraph (c)(8) of this section. On its annual return for determination year 1979, the first year of its first election, X can demonstrate, under paragraph (b)(2) of this section, that its lob-bying expenditures during 1979 ($100,000) do not exceed 150 percent of its lobbying non-taxable amount for 1979 ($120,000). For deter-mination year 1980, under paragraph (b)(2), X can demonstrate that the sum of its lobbying expenditures for 1979 and 1980 ($200,000) does not exceed 150 percent of the sum of its lob-bying nontaxable amounts for 1979 and 1980 ($210,000). For 1981, under paragraph (b)(2), X can demonstrate that the sum of its lobbying expenditures for 1979, 1980, and 1981 ($320,000) does not exceed 150 percent of the sum of its lobbying nontaxable amounts for 1979, 1980, and 1981 ($382,500). For each of the deter-mination years 1979, 1980, and 1981, the first three years of its first election, X satisfies the requirements of paragraph (b)(2). Accord-ingly, no determination under paragraph (b)(1) of this section is required for those years, and X is not denied tax exemption by reason of section 501(h). (4) Under paragraph (b)(1) of this section, X must determine for its determination year 1982 whether it has normally made lobbying expenditures in excess of the lobbying ceil-ing amount. This determination takes into account expenditures in base years 1979 through 1982. The sum of Xs lobbying ex-penditures for the base years ($420,000) does not exceed 150 percent of the sum of the lob-bying nontaxable amounts for the base years (150%$355,000=$532,500). Accordingly, X is not denied tax exemption by reason of sec-tion 501(h). Example 2. (1) The following table contains information used in this example concerning W. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00062 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15053 Internal Revenue Service, Treasury 1.501(h)3 Year Exempt pur-pose expendi-tures (EPE) (dollars) Calculation Lobbying non-taxable amount (LNTA) (dol-lars) Lobbying ex-penditures (LE) (dollars) Grass roots nontaxable amount (25 percent of LNTA) (dol-lars) Grass roots expenditures (dollars) 1979 ................... 700,000 (20% of $500,000+15% of $200,000=).130,000 120,000 32,500 30,000 1980 ................... 800,000 (20% of $500,000+15% of $300,000=).145,000 100,000 36,250 60,000 1981 ................... 800,000 (20% of $500,000+15% of $300,000=).145,000 100,000 36,250 65,000 1982 ................... 900,000 (20% of $500,000+15% of $400,000=).160,000 150,000 40,000 65,000 Total ................ 3,200,000 ................................... 580,000 470,000 145,000 220,000 (2) Organization W, whose taxable year is the calendar year, made the expenditure test election under section 501(h) effective for taxable years beginning with 1979 and has not revoked the election. W has been treated as an organization described in section 501(c)(3) for each of its taxable years begin-ning within its taxable year 1974. (3) Under section 4911(a) and 56.49111(a), W must determine for each year for which the expenditure test election is effective whether it is liable for the 25 percent excise tax imposed by section 4911(a) on excess lob-bying expenditures. In 1980, 1981, and 1982, W has excess lobbying expenditures because its grass roots expenditures in each of those years exceeded its grass roots nontaxable amount for the year. Therefore, W is liable for the excise tax under section 4911(a) for those years. The tax imposed by section 4911(a) for 1980 is $5,937.50 {25%($60,000$36,250)= $5,937.50}. For 1981, the tax is $7,187.50. For 1982, the tax is $6,250. (4) On its annual return for its determina-tion years 1979, 1980, and 1981, the first three years of its first election, W demonstrates that it satisfies the requirements of para-graph (b)(2) of this section. Accordingly, no determination under paragraph (b)(1) of this section is required for those years, and W is not denied tax exemption by reason of sec-tion 501(h). (5) On its annual return for its determina-tion year 1982, W must determine under para-graph (b)(1) whether it has normally made lobbying expenditures or grass roots expendi-tures in excess of the corresponding ceiling amount. This determination takes into ac-count expenditures in base years 1979 through 1982. The sum of Ws lobbying ex-penditures for the base years ($470,000) does not exceed 150% of the sum of Ws lobbying nontaxable amounts for those years (150%$580,000=$870,000). However, the sum of Ws grass roots expenditures for the base years ($220,000) does exceed 150% of the sum of Ws grass roots nontaxable amonts for those years (150%$145,000=$217,500). Under section 501(h), W is denied tax exemption under section 501(a) as an organization de-scribed in section 501(c)(3) for its taxable year 1983. For its taxable year 1984 and any taxable year thereafter, W is exempt from tax as an organization described in section 501(c)(3) only if W applies for recognition of its exempt status under paragraph (d) of this section and is recognized as exempt from tax. Example 3. (1) The following table contains information used in this example concerning organization Y. Taxable Year Exempt pur-pose expendi-tures (EPE) (dollars) Calculation Lobbying non-taxable amount (LNTA) (dol-lars) Lobbying ex-penditures (LE)(dollars) Grass roots nontaxable amount (25 percent of LNTA)(dollars) Grass roots expenditures (dollars) 1977 ................... 700,000 (20% of $500,000+15% of $200,000=).130,000 182,000 32,500 30,000 1978 ................... 800,000 (20% of $500,000+15% of $300,000=).145,000 224,750 36,250 35,000 Subtotal ........... 1,500,000 ................................... 275,000 406,750 68,750 65,000 VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00063 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15054 26 CFR Ch. I (4113 Edition) 1.501(h)3 Taxable Year Exempt pur-pose expendi-tures (EPE) (dollars) Calculation Lobbying non-taxable amount (LNTA) (dol-lars) Lobbying ex-penditures (LE)(dollars) Grass roots nontaxable amount (25 percent of LNTA)(dollars) Grass roots expenditures (dollars) 1979 ................... 900,000 (20% of $500,000+15% of $400,000=).160,000 264,000 40,000 50,000 Totals: ............. 2,400,000 ................................... 435,000 670,750 108,750 115,000 (2) Organization Y, whose taxable year is the calendar year, was first treated as an or-ganization described in section 501(c)(3) on February 1, 1977. Y made the expenditure test election under section 501(h) effective for taxable years beginning with 1977 and has not revoked the election. (3) For 1977, Y has excess lobbying expendi-tures of $52,000 because its lobbying expendi-tures ($182,000) exceed its lobbying non-taxable amount ($130,000) for the taxable year. Accordingly, Y is liable for the 25 per-cent excise tax imposed by section 4911(a). The amount of the tax is $13,000 [25%($182,000$130,000)=$13,000]. (4) For 1978, Y again has excess lobbying expenditures and is again liable for the 25 percent excise tax imposed by section 4911(a). The amount of the tax is $19,937.50 [25%($224,750$145,000)=$19,937.50]. (5) For 1979, Ys lobbying expenditures ($264,000) exceed its lobbying nontaxable amount ($160,000) by $104,000, and its grass roots expenditures ($50,000) exceed its grass roots nontaxable amount ($40,000) by $10,000. Under 56.49111(b), Ys excess lobbying ex-penditures are the greater of $104,000 or $10,000. The amount of the tax, therefore, is $26,000 [25%$104,000=$26,000]. (6) Under paragraph (c)(8) of this section, 1977 is not a determination year because it is the first year for which the organization is treated as described in section 501(c)(3). For 1977, Y need not determine whether it has normally made lobbying expenditures or grass roots expenditures in excess of the cor-responding ceiling amount for purposes of determining whether it is denied exemption under section 501(h) for its taxable year 1978. (7) For determination year 1978, Y must de-termine whether it has normally made lob-bying or grass roots expenditures in excess of the corresponding ceiling amount, taking into account expenditures for the base years 1977 and 1978. For Y, the determination under paragraph (b)(2) of this section considers the same base years as the determination under paragraph (b)(1) of this section and is, there-fore, redundant. Accordingly, Y proceeds to determine, under (b)(1), whether it is denied exemption. Ys grass roots expenditures for 1977 and 1978 ($65,000) did not exceed 150 per-cent of the sum of its grass roots nontaxable amounts for those years ($103,125). Ys lob-bying expenditures for 1977 and 1978 ($406,750) did not exceed 150% of its lobbying non-taxable amount for those years (150%$275,000=$412,500). Therefore, Y is not denied tax exemption under section 501(h) for its taxable year 1979. (8) For determination year 1979, the sum of Ys grass roots expenditures in base years 1977, 1978, and 1979 does not exceed 150 per-cent of its grass roots nontaxable amount (calculation omitted). However, the sum of Ys lobbying expenditures for the base years ($670,750) does exceed 150% of the sum of the lobbying nontaxable amounts for those years (150%$435,000=$652,500). Since Y was not de-scribed in section 501(c)(3) prior to 1977, only the years 1977, 1978, and 1979 may be consid-ered in determining whether Y has normally made lobbying expenditures in excess of its lobbying ceiling. Therefore, Y determines that it has normally made lobbying expendi-tures in excess of its lobbying ceiling. Under section 501(h), Y is denied tax exemption under section 501(a) as an organization de-scribed in section 501(c)(3) for its taxable year 1980. For its taxable year 1981, and any taxable year thereafter, Y is exempt from tax as an organization described in section 501(c)(3) only if Y applies for recognition of its exempt status under paragraph (d) of this section and is recognized as exempt from tax. Example 4. Organization M made the ex-penditure test election under section 501(h) effective for taxable years beginning with 1977 and has not revoked the election. M has $500,000 of exempt purpose expenditures dur-ing each of the years 1981 through 1984. In ad-dition, during each of those years, M spends $75,000 for direct lobbying and $25,000 for grass roots lobbying. Since the amount ex-pended for Ms lobbying (both total lobbying and grass roots lobbying) is within the re-spective nontaxable expenditure limitations, M is not liable for the 25 percent excise tax imposed under section 4911(a) upon excess lobbying expenditures, nor is M denied tax- exempt status by reason of section 501 (h). Example 5. Assume the same facts as in Ex-ample 4, except that, on behalf of M, numer-ous unpaid volunteers conduct substantial lobbying activities with no reimbursement. Since the substantial lobbying activities of the unpaid volunteers are not counted to-wards the expenditure limitations and the amount expended for Ms lobbying is within VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00064 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15055 Internal Revenue Service, Treasury 1.5021 the respective nontaxable expenditure limi-tations, M is not liable for the 25 percent ex-cise tax under section 4911, nor is M denied tax-exempt status by reason of section 501(h). [T.D. 8308, 55 FR 35589, Aug. 31, 1990] 1.501(k)1 Communist-controlled or-ganizations. Under section 11(b) of the Internal Security Act of 1950 (50 U.S.C. 790(b)), as amended, which is made applicable to the Code by section 7852(b) of that Code, no organization is entitled to ex-emption under sections 501(a) or 521(a) for any taxable year if at any time dur-ing such year such organization is reg-istered under section 7 of such Act or if there is in effect a final order of the Subversive Activities Control Board es-tablished by section 12 of such Act re-quiring such organization to register under section 7 of such Act, or deter-mining that it is a Communist-infil-trated organization. [T.D. 6500, 25 FR 11737, Nov. 26, 1960; redesig-nated by T.D. 8100, 51 FR 31615, Sept. 4, 1986] 1.5021 Feeder organizations. (a) In the case of an organization op-erated for the primary purpose of car-rying on a trade or business for profit, exemption is not allowed under section 501 on the ground that all the profits of such organization are payable to one or more organizations exempt from tax-ation under section 501. In determining the primary purpose of an organiza-tion, all the circumstances must be considered, including the size and ex-tent of the trade or business and the size and extent of those activities of such organization which are specified in the applicable paragraph of section 501. (b) If a subsidiary organization of a tax-exempt organization would itself be exempt on the ground that its ac-tivities are an integral part of the ex-empt activities of the parent organiza-tion, its exemption will not be lost be-cause, as a matter of accounting be-tween the two organizations, the sub-sidiary derives a profit from its deal-ings with its parent organization, for example, a subsidiary organization which is operated for the sole purpose of furnishing electric power used by its parent organization, a tax-exempt edu-cational organization, in carrying on its educational activities. However, the subsidiary organization is not exempt from tax if it is operated for the pri-mary purpose of carrying on a trade or business which would be an unrelated trade or business (that is, unrelated to exempt activities) if regularly carried on by the parent organization. For ex-ample, if a subsidiary organization is operated primarily for the purpose of furnishing electric power to consumers other than its parent organization (and the parents tax-exempt subsidiary or-ganizations), it is not exempt since such business would be an unrelated trade or business if regularly carried on by the parent organization. Simi-larly, if the organization is owned by several unrelated exempt organiza-tions, and is operated for the purpose of furnishing electric power to each of them, it is not exempt since such busi-ness would be an unrelated trade or business if regularly carried on by any one of the tax-exempt organizations. For purposes of this paragraph, organi-zations are related only if they consist of: (1) A parent organization and one or more of its subsidiary organizations; or (2) Subsidiary organizations having a common parent organization An exempt organization is not related to another exempt organization merely because they both engage in the same type of exempt activities. (c) In certain cases an organization which carries on a trade or business for profit but is not operated for the pri-mary purpose of carrying on such trade or business is subject to the tax im-posed under section 511 on its unrelated business taxable income. (d) Exception(1) Taxable years begin-ning before January 1, 1970. For purposes of section 502 and this section, for tax-able years beginning before January 1, 1970, the term trade or business does not include the rental by an organization of its real property (including personal property leased with the real property). (2) Taxable years beginning after De-cember 31, 1969. For purposes of section 502 and this section, for taxable years beginning after December 31, 1969, the term trade or business does not include: (i) The deriving of rents described in section 512(b)(3)(A), VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00065 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15056 26 CFR Ch. I (4113 Edition) 1.503(a)1 (ii) Any trade or business in which substantially all the work in carrying on such trade or business is performed for the organization without compensa-tion, or (iii) Any trade or business (such as a thrift shop) which consists of the selling of merchandise, substantially all of which has been received by the organi-zation as gifts or contributions For purposes of the exception described in subdivision (i) of this subparagraph, if the rents derived by an organization would not be excluded from unrelated business income pursuant to section 512(b)(3) and the regulations there-under, the deriving of such rents shall be considered a trade or business. (3) Cross references and special rules. (i) For determination of when rents are excluded from the tax on unrelated business income see section 512(b)(3) and the regulations thereunder. (ii) The rules contained in 1.513 1(e)(1) shall apply in determining whether a trade or business is de-scribed in section 502(b)(2) and subpara-graph (2)(ii) of this paragraph. (iii) The rules contained in 1.513 1(e)(3) shall apply in determining whether a trade or business is de-scribed in section 502(b)(3) and subpara-graph (2)(iii) of this paragraph. [T.D. 6500, 25 FR 11737, No. 26, 1960, as amend-ed by T.D. 6662, 28 FR 6973, July 29, 1963; T.D. 7033, 35 FR 19997, Dec. 31, 1970] 1.503(a)1 Denial of exemption to cer-tain organizations engaged in pro-hibited transactions. (a)(1) Prior to January 1, 1970, section 503 applies to those organizations de-scribed in sections 501(c)(3), 501(c)(17), and section 401(a) except: (i) A religious organization (other than a trust); (ii) An educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on; (iii) An organization which normally receives a substantial part of its sup-port (exclusive or income received in the exercise or performance by such or-ganization of its charitable, edu-cational, or other purpose or function constituting the basis for its exemp-tion under section 501(a)) from the United States or any State or political subdivision thereof or from direct of indirect contributions from the general public, (iv) An organization which is oper-ated, supervised, controlled or prin-cipally supported by a religious organi-zation (other than a trust) which is itself not subject to the provisions of this section; and (v) An organization the principal pur-poses or functions of which are the pro-viding of medical or hospital care or medical education or medical research or agricultural research. (2) Effective January 1, 1907, and prior to January 1, 1975, section 503 shall apply only to organizations de-scribed in section 501(c) (17) or (18) or section 401(a). (3) Effective January 1, 1975, section 503 shall apply only to organization de-scribed in section 501(c) (17) or (18) or described in section 401(a) and referred to in section 4975(g) (2) or (3). (b) The prohibited transactions enu-merated in section 503(b) are in addi-tion to and not in limitation of the re-strictions contained in section 501(c) (3), (17), or (18) or section 401(a). Even though an organization has not en-gaged in any of the prohibited trans-actions referred to in section 503(b), it still may not qualify for tax exemp-tions in view of the general provisions of section 501(c) (3), (17), or (18) or sec-tion 401(a). Thus, if a trustee or other fiduciary of the organization (whether or not he is also a creater or such orga-nization) enters into a transaction with the organization, such trans-action will be closely scrutinized in the light of the fiduciary principle requir-ing undivided loyalty to ascertain whether the organization is in fact being operated for the stated exempt purpose. (c) An organization(1) Described in section 501(c)(3) which after July 1, 1950, but before January 1, 1970, has en-gaged in any prohibited transaction as defined in section 503(b), unless it is ex-cepted by the provisions of paragraph (a)(1) of this section; (2) Described in section 401(a) and re-ferred to in section 4975(g) (2) or (3) which after March 1, 1954, has engaged VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00066 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15057 Internal Revenue Service, Treasury 1.503(b)1 in any prohibited transaction as de-fined in section 503(b); (3) Described in section 401(a) and not referred to in section 4975(g) (2) or (3) which after March 1, 1954, but before January 1, 1975, has engaged in any prohibited transaction as defined in section 503(b) or which after December 31, 1962, but before January 1, 1975, has engaged in any prohibited transaction as defined in section 503(g) prior to its repeal by section 2003(b)(5) of the Em-ployee Retirement Income Security Act of 1974 (88 Stat. 978); (4) Described in section 501(c)(17) which after December 31, 1959, has en-gaged in any prohibited transaction as defined in section 503(b); or (5) Described in section 501(c)(18) which after December 31, 1969, has en-gaged in any prohibited transaction de-scribed in section 503(b) Shall not be exempt from taxation under section 501(a) for any taxable year subsequent to the taxable year in which there is mailed to it a notice in writing by the Commissioner that it has engaged in such prohibited trans-actions. Such notification by the Com-missioner shall be by registered or cer-tified mail to the last known name and address of the organization. However, notwithstanding the requirement of notification by the Commissioner, the exemption shall be denied with respect to any taxable year if such organiza-tion during or prior to such taxable year commenced the prohibited trans-action with the purpose of diverting in-come or corpus from its exempt pur-poses and such transaction involved a substantial party of the income or cor-pus of such organization. For the pur-pose of this section, the term taxable year means the established annual ac-counting period of the organization; or, if the organization has no such estab-lished annual accounting period, the taxable year of the organizations means a calendar year. See 26 CFR 1.503(j)1 (rev. as of Apr. 1, 1974) for provisions relating to the definition of prohibited transactions in the case of trusts bene-fitting certain owner-employees after December 31, 1962, but prior to January 1, 1975. See also section 2003 (c)(1)(B) of the Employee Retirement Income Se-curity Act of 1974 (88 Stat. 978) in the case of an organization described in section 401(a) with respect to which a disqualified person elects to pay a tax in the amount and manner provided with respect to the tax imposed by sec-tion 4975 of the Code so that the orga-nization may avoid denial of exemption under section 503. For further guidance regarding the definition of last known address, see 301.62122 of this chapter. (d) The application of section 503(b) may be illustrated by the following ex-amples: Example 1. A creates a foundation in 1954 ostensibly for educational purposes. B, a trustee, accumulates the foundations in-come from 1957 until 1959 and then uses a substantial part of this accumulated income to send As children to college. The founda-tion would lose its exemption for the taxable years 1957 through 1959 and for subsequent taxable years until it regains its exempt sta-tus. Example 2. If under the facts in Example 1 such private benefit was the purpose of the foundation from its inception, such founda-tion is not exempt by reason of the general provisions of section 501(c)(3), without regard to the provisions of section 503, for all years since its inception, that is, for the taxable years 1954 through 1959 and subsequent tax-able years, since under section 501(c)(3) the organization must be organized and operated exclusively for exempt purposes. See 1.501(c)(3)1. [T.D. 7428, 41 FR 34621, Aug. 16, 1976, as amended by T.D. 8939, 66 FR 2819, Jan. 12, 2001] 1.503(b)1 Prohibited transactions. (a) In general. The term prohibited transaction means any transaction set forth in section 503(b) engaged in by any organization described in para-graph (a) of 1.503(a)1. Whether a transaction is a prohibited transaction depends on the facts and circumstances of the particular case. This section is intended to deny tax-exempt status to such organizations which engage in certain transactions which inure to the private advantage of (1) the creator of such organization (if it is a trust); (2) any substantial contributor to such or-ganization; (3) a member of the family (as defined in section 267(c)(4) of an in-dividual who is such creator of or such substantial contributor to such organi-zation; or (4) a corporation controlled, as set forth in section 503(b), by such creator or substantial contributor. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00067 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15058 26 CFR Ch. I (4113 Edition) 1.503(b)1 (b) Loans as prohibited transactions under section 503(b)(1)(1) Adequate se-curity. For the purposes of section 503(b)(1), which treats as prohibited transactions certain loans by an orga-nization without receipt of adequate security and a reasonable rate of inter-est, the term adequate security means something in addition to and sup-porting a promise to pay, which is so pledged to the organization that it may be sold, foreclosed upon, or otherwise disposed of in default of repayment of the loan, the value and liquidity of which security is such that it may rea-sonably be anticipated that loss of principal or interest will not result from the loan. Mortgages or liens on property, accommodation endorse-ments of those financially capable of meeting the indebtedness, and stock or securities issued by corporations other than the borrower may constitute se-curity for a loan to the persons or or-ganizations described in section 503(b). Stock of a borrowing corporation does not constitute adequate security. A borrowers evidence of indebtedness, ir-respective of its name, is not security for a loan, whether or not it was issued directly to the exempt organization. However, if any such evidence of in-debtedness provides for security that may be sold, foreclosed upon, or other-wise disposed of in default of repay-ment of the loan, there may be ade-quate security for such loan. If an or-ganization subject to section 503(b) purchases debentures issued by a per-son specified in section 503(b), the pur-chase is considered, for purposes of sec-tion 503(b)(1), as a loan made by the purchaser to the issuer on the date of such purchase. For example, if an ex-empt organization subject to section 503(b) makes a purchase through a reg-istered security exchange of debentures issued by a person described in section 503(b), and owned by an unknown third party, the purchase will be considered as a loan to the issuer by the pur-chaser. For rules relating to loan of funds to, or investment of funds in stock or securities of, persons de-scribed in section 503(b) by an organiza-tion described in section 401(a), see paragraph (b)(5) of 1.4011. (2) Effective dates. The effective dates for the application of the definition of adequate security in paragraph (b)(1) of this paragraph are: (i) March 15, 1956, for loans (other than debentures) made after March 15, 1956; (ii) January 31, 1957, for loans (other than debentures) made before March 16, 1956, and continued after January 31, 1957; (iii) November 8, 1956, for debentures which were purchased after November 8, 1956; (iv) December 1, 1958, for debentures which were purchased before November 9, 1956, and held after December 1, 1958; (v) If an employees pension, stock bonus, or profit-sharing trust described in section 401(a) made a loan before March 1, 1954, repayable by its terms after December 31, 1955, and which would constitute a prohibited trans-action if made on or after March 1, 1954, the loan shall not constitute a prohibited transaction if held until ma-turity (determined without regard to any extension or renewal thereof); (vi) January 1, 1960, for loans (includ-ing the purchase of debentures) made by supplemental unemployment ben-efit trusts, described in section 501 (c)(17); (vii) January 1, 1970, for loans (in-cluding the purchase of debentures) made by employees contribution pen-sion plan trusts described in section 501(c)(18). (3) Certain exceptions to section 503(b)(1). See section 503(e) and 1.503(e)1, 1.503(e)2, and 1.503(e)3 for special rules providing that certain ob-ligations acquired by trusts described in section 401(a) or section 501(c) (17) or (18) shall not be treated as loans made without the receipt of adequate secu-rity for purposes of section 503(b)(1). See section 503(f) and 1.503(f)1 for an exception to the application of sections 503(b)(1) for certain loans made by em-ployees trusts described in section 401(a). (c) Examples. The principles of this section are illustrated by the following examples: (Assume that section 503 (e) and (f) are not applicable.) Example 1. A, creator of an exempt trust subject to section 503, borrows $100,000 from such trust in 1960, giving his unsecured promissory note. The net worth of A is $1,000,000. The net worth of A is not security VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00068 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15059 Internal Revenue Service, Treasury 1.503(c)1 for such loan and the transaction is a prohib-ited transaction. If, however, the note is se-cured by a mortgage on property of suffi-cient value, or is accompanied by acceptable collateral of sufficient value, or carries with it the secondary promise of repayment by an accommodation endorser financially capable of meeting the indebtedness, it may be ade-quately secured. However, subordinated de-bentures bonds of a partnership which are guaranteed by the general partners are not adequately secured since the general part-ners are liable for the firms debt and their guaranty adds no additional security. Example 2. Assume the same facts as in ex-ample 1 except that As promissory note in the amount of $100,000 to the trust is secured by property which has a fair market value of $75,000. As promissory note secured to the extent of $75,000 is not adequately secured within the meaning of section 503(b)(1) since the security at the time of the transaction must be sufficient to repay the indebtedness, interest, and charges which may pertain thereto. Example 3. Corporation M, a substantial contributor to an exempt organization sub-ject to section 503, borrows $150,000 from such organization in 1960, giving its promissory note accompanied by stock of the borrowing corporation with a fair market value of $200,000. Since promissory notes and deben-tures have priority over stock in the event of liquidation of the corporation, stock of a borrowing corporation is not adequate secu-rity. Likewise, debenture bonds which are convertible on default into voting stock of the issuing corporation do not constitute adequate security under section 503(b)(1). Example 4. B, creator of an exempt trust subject to section 503, borrows $100,000 from such trust in 1960, giving his secured promis-sory note at the rate of 3 percent interest. The prevailing rate of interest charged by fi-nancial institutions in the community where the transaction takes place is 5 percent for a loan of the same duration and similarly se-cured. The loan by the trust to the grantor is a prohibited transaction since section 503(b)(1) requires both adequate security and a reasonable rate of interest. Further, a promise to repay the loan plus a percentage of future profits which may be greater than the prevailing rate of interest does not meet the reasonable rate of interest requirement. Example 5. N Corporation, a substantial contributor to an exempt organization sub-ject to section 503 borrows $50,000 on or after March 16, 1956, from the organization. If the loan is not adequately secured, the organiza-tion has committed a prohibited transaction at the time the loan was made. If the loan had been made on or before March 15, 1956, and is continued after January 31, 1957, it must be adequately secured on February 1, 1957, or it will be considered a prohibited transaction on that date. However, if the ex-empt organization were an employees trust, described in section 401(a), and the loan were made before March 1, 1954, repayable by its terms after December 31, 1955, it would not have to be adequately secured on February 1, 1957. Moreover, if the exempt organization were a supplemental unemployment benefit trust, described in section 501(c)(17), and the loan were made before January 1, 1960, re-payable by its terms after December 31, 1959, it would not have to be adequately secured on January 1, 1960. Example 6. An exempt organization subject to section 503 purchases a debenture issued by O Corporation, which is a substantial con-tributor to the organization. The organiza-tion purchases the debenture in an arms length transaction from a third person on or after November 9, 1956. The purchase is con-sidered as a loan by the organization to O Corporation. The loan must be adequately secured when it is made, or it is considered as a prohibited transaction at that time. If the organization purchased the debenture be-fore November 9, 1956, and holds it after De-cember 1, 1958, the debenture must be ade-quately secured on December 2, 1958, or it will then be considered as a prohibited trans-action. However, if the organization were an employees trust described in section 401(a), and if the debenture were purchased before March 1, 1954, and its maturity date is after December 31, 1955, the debenture does not have to be adequately secured. Moreover, if the organization were an employees con-tribution pension plan trust described in sec-tion 501(c)(18), and if the debenture were pur-chased before January 1, 1970, and its matu-rity date is after December 31, 1969, the de-benture does not have to be adequately se-cured. [T.D. 7428, 41 FR 34621, Aug. 16, 1976] 1.503(c)1 Future status of organiza-tions denied exemption. (a) Any organization described in sec-tion 501(c) (3), (17), or (18), or an em-ployees trust described in section 401(a), which is denied exemption under section 501(a) by reason of the provi-sions of section 503(a), may file, in any taxable year following the taxable year in which notice of denial was issued, a claim for exemption. In the case of or-ganizations described in section 501(c) (3), (17), or (18), the appropriate exemp-tion application shall be used for this purpose, and shall be filed with the dis-trict director. In the case of an enmployees trust described in section 401(a), the information described in 1.404(a)2 shall be submitted with a VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00069 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15060 26 CFR Ch. I (4113 Edition) 1.503(d)1 letter claiming exemption. All employ-ees trust described in section 401(a) shall submit this information to the district director with whom a request for a determination as to its qualifica-tion under section 401 and exemption under section 501 may be submitted under paragraph (s) of 601.201 of this chapter (Statement of Procedural Rules). A claim for exemption must contain or have attached to it, in addi-tion to the information generally re-quired of such an organization claim-ing exemption as an organization de-scribed in section 501(c) (17), or (18), or section 401(a) (or section 501(c)(3) prior to January 1, 1970), a written declara-tion made under the penalities of per-jury by principal officer of such organi-zation authorized to make such dec-laration that the organization will not knowingly again engage in a prohibited transaction, (as defined in section 503(b) (or 4975(c) if such section applies to such organization)). In the case of section 501(c)(3) organizations which have lost their exemption after Decem-ber 31, 1969, pursuant to section 503, a claim for exemption must contain or have attached to it a written agree-ment made under penalities of perjury by a principal officer of such organiza-tion authorized to make such agree-ment that the organization will not violate the provisions of chapter 42. In addition, such organization must com-ply with the rules for governing instru-ments as prescribed in 1.5083. See 1.501(a)1 for proof of exemption re-quirements in general. (b) If the Commissioner is satisfied that such organization will not know-ingly again engage in a prohibited transaction (as defined under section 503(b) or 4975(c), as applicable to such organization) or in the case of a section 501(c)(3) organization, will not violate the provisions of chapter 42, and the or-ganization also satisfied all the other requirements under section 501(c) (3), (17), or (18), or section 401(a), the orga-nization will be so notified in writing. In such case the organization will be exempt (subject to the provisions of section 501(c)(3), or sections 501(c) (17), (18) or 401(a), and 503, and 504 when ap-plicable) with respect to the taxable years subsequent to the taxable year in which the claim described in section 503(c) is filed. Section 503 contemplates that an organization denied exemption because of the terms of such section will be subject to taxation for at least one full taxable year. For the purpose of this section, the term taxable year means the established annual account-ing period of the organization; or, if the organization has no such estab-lished annual accounting period, the taxable year of the organization means the calendar year. (c) For taxable years beginning after December 31, 1969, the denial of an ex-emption pursuant to this section, for a taxable year prior to January 1, 1970, of an organization described in section 501(c)(3) shall not cause such organiza-tion to cease to be described in section 501(c)(3) for purposes of part II of sub-chapter F, chapter 1 and for purposes of the application of chapter 42 taxes. (d) In the case of an organization de-scribed in section 501(c)(3), which has lost its exemption pursuant to section 503, and which has not notified the Commissioner that it is applying for recognition of its exempt status under section 508(a) and this section, no gift or contribution made after December 31, 1969, which would otherwise be de-ductible under section 170, 642(c), or 545(b)(2) shall be allowed as a deduc-tion. For rules relating to the denial of deductions with respect to gifts or con-tributions made before January 1, 1970, see, 1.503(e)4. [T.D. 7428, 41 FR 34622, Aug. 16, 1976, as amended by T.D. 7896, 48 FR 23817, May 27, 1983] 1.503(d)1 Cross references. For provisions relating to loans de-scribed in section 503(b)(1) by a trust described in section 401(a), see 1.503(b)1 and section 503 (e) and (f) and the regulations thereunder. [T.D. 7428, 41 FR 34623, Aug. 16, 1976] 1.503(e)1 Special rules. (a) In general. (1) Section 503(e) pro-vides that for purposes of section 503(b)(1) (relating to loans made with-out the receipt of adequate security and a reasonable rate of interest) the acquisition of a bond, debenture, note, or certificate or other evidence of in-debtedness shall not be treated as a VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00070 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15061 Internal Revenue Service, Treasury 1.503(e)1 loan made without the receipt of ade-quate security if certain requirements are met. Those requirements are de-scribed in 1.503(e)2. (2) Section 503(e) does not affect the requirement in section 503(b)(1) of a reasonable rate of interest. Thus, al-though the acquistion of a certificate of indebtedness which meets all of the requirements of section 503(e) and of 1.503(e)2 will not be considered as a loan made without the receipt of ade-quate security, the acquisition of such an indebtedness does consitute a pro-hibited transaction if the indebtedness does not bear a reasonable rate of in-terest. (3) The provisions of section 503(e) do not limit the effect of section 401(a) and 1.4012, section 501(c)(17)(A)(i), or section 501(c)(18)(A), all relating to the use of diversion of corpus or incopme of the respective employee trusts. Fur-thermore, the provisions of section 503(e) do not limit the effect of any of the provisions of section 503 other than section 503(b)(1). Thus, for example, al-though a loan made by employees trust described in section 503(a)(1)(B) meets all the requirements of section 503(e) and therefore is not treated as a loan made without the receipt of ade-quate security, such an employees trust making such a loan will lose its exempt status if the loan is not consid-ered as made for the exclusive benefit of the employees or their beneficiaries. Similarly, a loan which meets the re-quirements of section 503(e) will con-stitute a prohibited transaction within the meaning of section 503(b)(6) if it re-sults in a substantial diversion of the trusts income or corpus to a person de-scribed in section 503(b). (b) Definitions. For purposes of sec-tion 503(e): (1) The term obligation means bond, debenture, note, or certificate or other evidence of indebtedness. (2) The term issuer includes any per-son described in section 503(b) who issues an obligation. (3)(i) The term person independent of the issuer means a person who is not re-lated to the issuer by blood, by mar-riage, or by reason of any substantial business interests. Persons who will be considered not to be independent of the issuer include but are not limited to: (a) The spouse, ancestor, lineal de-scendant, or brother or sister (whether by whole or half blood) of an individual who is the issuer of an obligation; (b) A corporation controlled directly or indirectly by an individual who is the issuer, or directly or indirectly by the spouse, ancestor, lineal descendant, or brother or sister (whether by whole or half blood) of an individual who is the issuer; (c) A corporation which directly or indirectly controls, or is controlled by, a corporate issuer; (d) A controlling shareholder of a corporation which is the issuer, or which controls the issuer; (e) An officer, director, or other em-ployee of the issuer, of a corporation controlled by the issuer, or of a cor-poration which controls the issuer; (f) A fiduciary of any trust created by the issuer, by a corporation which con-trols the issuer, or by a corporation which is controlled by the issuer; or (g) A corporation controlled by a per-son who controls a corporate issuer. (ii) For purposes of paragraph (b)(3)(i) of this section, the term control means, with respect to a corporation, direct or indirect ownership of 50 percent or more of the total combined voting power of all voting stock or 50 percent or more of the total value of shares of all classes of stock. If the aggregate amount of stock in a corporation owned by an individual and by the spouse, ancestors, lineal descendants, brothers and sisters (whether by whole of half blood) of the individual is 50 percent or more of the total combined voting power of all voting stock or is 50 percent or more of the total value of all classes of stock, then each of these persons shall be considered as the con-trolling shareholder of the corporation. (iii) In determining family relation-ships for purposes of paragraph (b)(3)(i) of this section, a legally adopted child of an individual shall be treated as a child of such individual by blood. (4) The term issue means all the obli-gations of an issuer which are offered for sale on substantially the same terms. Obligations shall be considered offered for sale on substantially the same terms if such obligation would, at the same time and under the same cir-cumstances, be traded on the market VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00071 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15062 26 CFR Ch. I (4113 Edition) 1.503(e)2 at the same price. On the other hand, if the terms on which obligations are of-fered for sale differ in such manner as would cause such obligations to be traded on the market at different prices, then such obligations are not part of the same issue. The following are examples of terms which, if dif-ferent, would cause obligations to be traded on the market at different prices: (i) Interest rate; (ii) Maturity date; (iii) Collateral; and (iv) Conver-sion provisions The fact that obligations are offered for sale on different dates will not pre-clude such obligations from being part of the same issue if they all mature on the same date and if the terms on which they are offered for sale are oth-erwise the same, since such obligations would, at the same time and under the same conditions, be traded on the mar-ket at the same price. Obligations shall not be considered part of the same issue merely because they are part of the same authorization or because they are registered as part of the same issue with the Securities and Exchange Com-mission. [T.D. 7428, 41 FR 34623, Aug. 16, 1976] 1.503(e)2 Requirements. (a) In general. The requirements which must be met under section 503(e) for an obligation not to be treated as a loan made without the receipt of ade-quate security for purposes of section 503(b)(1) are described in paragraphs (b), (c), and (d) of this section. For pur-poses of this section, the term employee trust shall mean any of the three kinds of organizations described in section 503(a)(1). (b) Methods of acquisition(1) In gen-eral. The employee trust must acquire the obligation of the market, by pur-chase from an underwriter, or by pur-chase from the issuer, in the manner described in subparagraph (2), (3), or (4) of this paragraph. (2) On the market. (i) An obligation is acquired on the market when it is pur-chased through a national securities exchange which is registered with the Securities and Exchange Commission, or when it is purchased in an over-the- counter transaction. For purposes of the preceding sentence, securities pur-chased through an exchange which is not a national securities exchange reg-istered with the Securities and Ex-change Commission shall be treated as securities purchased in an over-the- counter transaction. (ii)(a) If the obligation is listed on a national securities exchange registered with the Securities and Exchange Com-mission, it must be purchased through such an exchange or in an over-the- counter transaction at a price not greater than the price of the obligation prevailing on such an exchange at the time of the purchase by the employee trust. (b) For purposes of section 503(e), the price of the obligation prevailing at the time of the purchase means the price which accurately reflects the market value of the obligation. In the case of an obligation purchased through a national securities exchange which is registered with the Securities and Exchange Commission, the price paid for the obligation will be consid-ered the prevailing price of the obliga-tion. In the case of an obligation pur-chased in an over-the-counter trans-action, the prevailing price may be the price at which the last sale of the obli-gation was affected on such national securities exchange immediately before the employee trusts purchase of such obligation on the same day or may be the mean between the highest and low-est prices at which sales were effected on such exchange on the same day or on the immediately preceding day or on the last day during which there were sales of such obligation or may be a price determined by any other meth-od which accurately reflects the mar-ket value of the obligation. (iii)(a) If the obligation is not listed on a national securities exchange which is registered with the Securities and Exchange Commission, it must be purchased in an over-the-counter transaction at a price not greater than the offering price for the obligation as established by current bid and asked prices quoted by persons independent of the issuer. (b) For purposes of section 503(e) the offering price for the obligation at the time of the purchase means the price which accurately reflects the market value of the obligation. The offering VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00072 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15063 Internal Revenue Service, Treasury 1.503(e)2 price may be the price at which the last sale of the obligation to a person independent of the issuer was effected immediately before the employee trusts purchase of such obligation on the same day or may be the mean be-tween the highest and lowest prices at which sales to persons independent of the issuer were effected on the same day or on the last day during which they were sales of such obligation or may be a price determinated by any other method which accurately reflects the market value of the obligation. The offering price for an obligation must be a valid price for the amount of the obli-gations which the trust is purchasing. For example, if an employees trust de-scribed in section 503(a)(1)(B) purchases 1,000 bonds of the employer corporation at the offering price established by cur-rent prices for a lot of 10 such bonds, such offering price may not be a valid price for 1,000 bonds and the purchase may therefore not meet the require-ments of this subdivision. For a pur-chase of an obligation to qualify under this subdivision, there must be suffi-cient current prices quoted by persons independent of the issuer to establish accurately the current value of the ob-ligation. Thus, if there are no current prices quoted by persons independent of the issuer, an over-the-counter transaction will not qualify under this subparagraph even though the obliga-tion was purchased in an armss length transaction from a person independent of the issuer. (iv) For purposes of this section, an over-the-counter transaction is one not executed on a national securities ex-change which is registered with the Se-curities and Exchange Commission. An over-the-counter transaction may be made through a dealer or an exchange which is not such a national securities exchange or may be made directly from the seller to the purchaser. (3) From an underwriter. An obligation may be purchased from an underwriter if it is purchased at a price not greater than: (i) The public offering price for the obligation as set forth in a prospectus or offering circular filed with the Secu-rities and Exchange Commission, or (ii) The price at which a substantial portion of the issue including such ob-ligation is acquired by persons inde-pendent of the issuer whichever is the lesser price. For pur-poses of this subparagraph, a portion of the issue will be considered substantial if the purchasers of such portion by persons independent of the issuer are sufficient to establish that fair market value of the obligations included in such issue. In determining whether the purchases are sufficient to establish the fair market value, all the sur-rounding facts and circumstances will be considered, including the number of independent purchasers, the aggregate amount purchased by each such inde-pendent purchaser, and the number of transactions. In the case of a large issue, purchases of a small percentage of the outstanding obligations may be considered purchases of a substantial portion of the issue; whereas, in the case of a small issue, purchases of a larger percentage of the outstanding obligations will ordinarily be required. The requirement in paragraph (b)(3)(ii) of this section contemplates purchase of the obligations by persons inde-pendent of the issuer contempora-neously with the purchase by the em-ployee trust. If a substantial portion has been purchased at different prices, the price of the portion may be based on the average of such prices, and if several substantial portions have been sold to persons independent of the issuer, the price of any of the substan-tial portions may be used for pusposes of this subparagraph. (4) From the issuer. An obligation may be purchased directly from the issuer at a price not greater than the price paid currently for a substantial portion of the same issue by persons inde-pendent of the issuer. This requirement contemplates purchase of a substantial portion of the same issue by persons independent of the issuer contempora-neously with the purchase by the em-ployee trust. For purposes of this sub-paragraph, a portion of the issue will be considered substantial if the pur-chases of such portion by persons inde-pendent of the issuer are sufficient to establish the fair market value of the obligations included in such issue. In determining whether the purchases are sufficient to establish the fair market value, all the surrounding facts and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00073 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15064 26 CFR Ch. I (4113 Edition) 1.503(e)2 circumstances will be considered, in-cluding the number of independent pur-chasers, the aggregage amount pur-chased by each such independent pur-chaser, and the number of trans-actions. In the case of a large issue, purchases of a small percentage of the outstanding obligations may be consid-ered purchases of a substantial portion of the issue; whereas, in the case of a small issue, purchases of a larger per-centage of the outstanding obligations will ordinarily be required. The price paid for a substantial portion of the issue may be determined in the manner privided in paragraph (b)(3) of this sec-tion. (c) Limitations on holdings of obliga-tions. (1) Immediately following acqui-sition of the obligation by the em-ployee trust: (i) Not more than 25 percent of the aggregate amount of the obligations issued in such issue and outstanding immediately after acquisition by the trust may be held by the trust, and (ii) At least 50 percent of such aggre-gate amount must be held by persons independent of the issuer. (2)(i) For purposes of paragraph (c)(1) of this section, an obligation is not considered as outstanding if it is held by the issuer. For example, if an obli-gation which has been issued and out-standing is repurchased and held by the issuer, without cancellation or retire-ment, such an obligation is not consid-ered outstanding. (ii) For purposes of paragraph (c)(1) of this section, the amounts of the obli-gations held by the trust and by per-sons independent of the issuer shall be computed on the basis of the face amount of the obligations. (d) Limitation on amount invested in obligations. (1)(i) Immediately following acquisition of the obligation, not more 25 percent of the assets of the employee trust may be invested in all obligations of all persons described in section 503(b). For purposes of determining the amount of the trusts assets which are invested in obligations of persons de-scribed in section 503(b) immediately following acquisition of the obligation, those obligations shall be valued as fol-lows: (a) Those obligations included in the acquisition in respect of which the per-centage test in the first sentence of this subdivision is being applied shall be valued at their adjusted basis, as provided in section 1011, relating to ad-justed basis for determining gain or loss; and (b) All other obligations of persons described in section 503(b) which were part of the trusts assets immediately before the acquisition of the obliga-tions described in (d)(1)(i)(a) of this section shall be valued at their fair market value on the day that the obli-gations described in (d)(1)(i)(a) of this section were acquired. For purposes of determining the total amount of the assets of the trust (including obliga-tions of persons described in section 503(b)), there shall be used the fair mar-ket value of those assets on the day the obligation is acquired. (ii) The application of the rules in paragraph (d)(1)(i) of this section may be illustrated by the following exam-ple: Example. On February 1, 1960, an exempt employees trust described in section 401(a) purchases unsecured debentures issued by the employer corporation for $1,000. At the time of this purchase, such debentures have a fair market value of $1,200. Immediately after the purchase of such unsecured deben-tures, the assets of the trust consist of the following: Cost Fair mar-ket value on Feb. 1, 1960 (a) Assets other than obligations of persons described in sec. 503(b) ......................................... $5,000 $7,800 (b) Obligations of persons de-scribed in sec. 503(b) acquired before Feb. 1, 1960 ................... 500 1,000 (c) Unsecured debentures of em-ployer purchased on Feb. 1, 1960 ........................................... 1,000 1,200 Immediately following acquisition of the unsecured debentures by the trust, the per-cent of the assets of the trust that are in-vested in all obligations of all persons de-scribed in section 503(b) is computed as fol-lows: (1) Obligations of persons described in section 503(b) acquired before Feb. 1, 1960 (valued at fair market value) ......................................... $1,000 (2) Unsecured debentures of employer pur-chased on Feb. 1, 1960 (valued at cost) ......... 1,000 (3) Total amount of trusts assets invested in ob-ligations of persons described in section 503(b) ((1) plus (2)) .......................................... 2,000 VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00074 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15065 Internal Revenue Service, Treasury 1.503(e)3 (4) Assets of the trust other than obligations of persons described in section 503(b) (valued at fair market value on Feb. 1, 1960) .................. 7,800 (5) Obligations of persons described in section 503(b) acquired before Feb. 1, 1960 (valued at fair market value on Feb. 1, 1960) .............. 1,000 (6) Unsecured debentures of employer pur-chased on Feb. 1, 1960 (valued at fair market value on Feb. 1, 1960) ..................................... $1,200 (7) Total assets of the trust valued at fair market value on Feb. 1, 1960 (sum of (4), (5), and (6)) .................................................................... 10,000 (8) Percent of assets of the trust invested in all obligations of all persons described in section 503(b) immediately following purchase of un-secured debentures on Feb. 1, 1960 ((3)(7), that is, $2,000$10,000) .................................. 20% (2) In determining for purposes of subparagraph (1) of this paragraph the amount invested in obligations of per-sons described in section 503(b), there shall be included amounts invested in any obligations issued by any such per-son, irrespective of whether the obliga-tion is secured, and irrespective of whether the obligation meets the con-ditions of section 503(e) or section 503(f). Obligations of persons described in section 503(b) other than the issuer of the obligation to which section 503(e) applies are also included within the 25 percent limitation. For example, if on February 19, 1959, an exempt em-ployees trust described in section 401(a) purchases unsecured debentures issued by the employer corporation in a transaction effected on the New York Stock Exchange, and if immediately after the purchase 10 percent of the trusts assets is invested in such deben-tures and 20 percent of its assets is in-vested in a loan made with adequate security on January 12, 1959, to the wholly-owned subsidiary of the em-ployer corporation, then the purchase of the employers debentures will not qualify under section 503(e), since 30 percent of the trusts assets are then invested in obligations of persons de-scribed in section 503(b). (e) Change of terms of an obligation. A change in terms of an obligation is con-sidered as the acquisition of a new obli-gation. If such new obligation is not adequately secured, the requirements of section 503(e) must be met at the time the terms of the obligation are changed for such section to be applica-ble to such new loan. [T.D. 7428, 41 FR 34624, Aug. 16, 1976] 1.503(e)3 Effective dates. (a) Section 503(e) and 1.503(e)1 and 1.503(e)3 are effective in the case of an employees trust described in section 401(a) for taxable years ending after March 15, 1956. Thus, if during a tax-able year ending before March 16, 1956, an employees trust made a loan which meets the requirements of section 503(e), such loan will not be treated as made without the receipt of adequate security and will not cause the loss of exemption for taxable years ending after March 15, 1956, although such loan was not considered adequately secured when made. (However, section 503 does not apply to organizations described in section 401(a) not referred to in section 4975(g) (2) or (3) for transactions occur-ring after December 31, 1974.) (b)(1) In the case of obligations ac-quired by an employees trust described in section 401(a) before September 2, 1958, which were held on that date, the requirements described in paragraphs (c) and (d) of 1.503(e)2 which were not satisfied immediately following the ac-quisition shall be treated as satisfied at that time if those requirements would have been satisfied had the obli-gations been acquired on September 2, 1958. For example, on January 3, 1955, an employees trust described in sec-tion 401(a) purchased through the New York Stock Exchange unsecured deben-tures issued by the employer corpora-tion. Under section 503(e) the acquisi-tion of such debentures by the trust will not be treated for taxable years ending after March 15, 1956, as a loan made without the receipt of adequate security if the debentures were held by the employees trust on September 2, 1958, and if the requirements of para-graphs (c) and (d) of 1.503(e)2 which were not met on January 3, 1955, were met on September 2, 1958, as if that date were the date of acquisition. (2) In the case of obligations acquired before September 2, 1958, which were not held by the employees trust de-scribed in section 401(a) on that date, only the requirements described in paragraph (b) of 1.503(e)2 must be sat-isfied for section 503(e) to be applicable to such acquisition. For example, if on December 5, 1956, an employees trust lent money to the employer corpora-tion by purchasing a debenture issued VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00075 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15066 26 CFR Ch. I (4113 Edition) 1.503(e)4 by the employer and if the trust sold the debenture on August 1, 1958, such loan would not be treated as made without the receipt of adequate secu-rity if the requirement described in paragraph (b) of 1.503(e)2 was met on December 5, 1956. (c) Section 503(e) and 1.503(e)1 and 1.503(e)2 are effective in the case of trusts described in section 501(c)(17) with respect to loans made, renewed, or, in the case of demand loans, contin-ued after December 31, 1959, and in the case of trusts described in section 501(c)(18) with respect to loans made, renewed or, in the case of demand loans, continued after December 31, 1969. (d) See paragraph (b)(2) of 1.503(b)1 for the effective dates for the applica-tion of the definition of adequate secu-rity. [T.D. 7428, 41 FR 34626, Aug. 16, 1976] 1.503(e)4 Disallowance of charitable deductions for certain gifts made before January 1, 1970. Paragraphs (a), (b), and (c) of this section shall apply only to gifts or con-tributions made before January 1, 1970, to an organization described in section 501(c)(3). For rules relating to the de-nial of deductions with respect to gifts or contributions made after December 31, 1969, see 1.503(c)1(d). (a) No gift or contribution which would otherwise be allowable as a char-itable or other deductions under sec-tion 170, 642(c), or 545(b)(2) shall be al-lowed as a deduction if made to an or-ganization described in section 501(c)(3) which at the time the gift or contribu-tion is made is not exempt under sec-tion 501(a) by reason of the provisions of section 503. (b) If an organization which is de-scribed in section 501(c)(3) is not ex-empt because it engaged in a prohib-ited transaction involving a substan-tial part of its income of corpus with the purpose of diverting its income or corpus from its exempt purposes, and if the organization receives a gift or con-tribution during, or prior to, its tax-able year in which such prohibited transaction occurred, then a deduction by the donor with respect to the gift or contribution shall not be disallowed under section 503(b) unless the donor (or any member of his family if the donor is an individual) is a party to such prohibited transaction. For the purpose of the preceding sentence fam-ily is defined in section 267(c)(4) and in-cludes brothers and sisters, whether by whole or half blood, spouse, ancestors, and lineal descendants. See the regula-tions under section 267(c). (c) The application of 1.503(e)4 may be illustrated by the following exam-ple: Example. In 1954, Corporation M, which files its income tax returns on the calendar year basis, creates a foundation purportedly for charitable purposes and deducts from its gross income for that year the amount of the gift to the foundation. Corporation M makes additional gifts to this foundation in 1955, 1956, and 1957, and takes charitable deduc-tions for such years. B, an individual, also contributes to the foundation in 1955, 1956, and 1957, and takes charitable deductions for such years. In 1955, the foundation com-mences purposely to divert its corpus to the benefit of Corporation M, and a substantial amount of such corpus is so diverted by the close of the taxable year 1956. For 1955 and subsequent taxable years, the exemption al-lowed the foundation as an organization de-scribed in section 501(c)(3) is denied by rea-son of the provisions of section 503(a). Both Corporation M and individual B would be dis-allowed any deduction for the contributions made during 1957 to the foundation. More-over, the charitable deductions taken by Corporation M for contributions to the foun-dation in the years 1955 and 1956 would also be disallowed since Corporation M was a party to the prohibited transactions. If the facts and surrounding cuircumstances indi-cate that the contribution in 1954 by Cor-poration M was for the purpose of the prohib-ited transaction, then the charitable deduc-tion for the year 1954 shall also be disallowed with respect to Corporation M, since the pro-hibited transaction would then have com-menced with the making of such contribu-tion and the exemption allowed the founda-tion would then be denied for 1954 by reason of the provisions of 1.503(e)4. Bs deduc-tions for his contributions for the years 1955 and 1956 will not be disallowed since he was not a party to the prohibited transaction. [T.D. 7428, 41 FR 34626, Aug. 16, 1976] 1.503(f)1 Loans by employers who are prohibited from pledging assets. (a) In general. (1) Section 503(f) pro-vides that section 503(b)(1) shall not apply to a loan made to the employer by an employees trust described in VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00076 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15067 Internal Revenue Service, Treasury 1.503(f)1 section 401(a) if the loan bears a rea-sonable rate of interest and certain conditions are met. Section 503(f) also applies to the renewal of loans to the employer and, in the case of demand loans, to the continuation of such loans. (2) The provisions of section 503(f) do not limit the effect of section 401(a) and 1.4012, relating to use or diver-sion of corpus or income of an employ-ees trust, or the effect of any of the provisions of section 503 other than section 503(b)(1). Consequently, al-though a loan made by an employees trust described in section 503(a)(1)(B) meets all the requirements of section 503(f) and therefore is not treated as a loan made without the receipt of ade-quate security, an employees trust making such a loan will lose its exempt status if the loan is not considered as made for the exclusive benefit of the employees or their beneficiaries. Simi-larly, a loan which meets the require-ments of section 503(f) will constitute a prohibited transaction within the meaning of section 503(b)(6) if it results in a substantial diversion of the trusts income or corpus to a person described in section 503(b). (b) Conditions. (1) Section 503(f) ap-plies to a loan only if, with respect to the making or renewal of the loan, the conditions described in paragraphs (b) (2), (3), and (4) of this section are met. For purpose of this paragraph, the mere continuance of a demand loan is not considered as the making or re-newal of such a loan. (2) The employer must be prohibited (at the time of the making or renewal of the loan) by any law of the United States or regulations thereunder from directly or indirectly pledging, as secu-rity for such a loan, a particular class or classes of his assets the value of which (at such time) represents more than one-half of the value of all his as-sets. If a loan is made or renewed when the employer is prohibited by a law of the United States (or the regulations thereunder) from pledging a class of his assets, the qualification of such a loan under section 503(f) will not be affected by a subsequent change in such law or regulations permitting the employer to pledge such assets, unless such loan is renewed after such change. See section 8(a) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78h(a)), which prohibits certain persons from pledging a class of assets as security for loans, and 12 CFR 220.5(a) (credit by brokers, dealers, and members of na-tional securities exchanges). (3) The making or renewal, as the case may be, must be approved in writ-ing as an investment which is con-sistent with the exempt purposes of the trust by a trustee who is independent of the employer, and such written ap-proval must not have been previously refused by any other such trustee. A trustee is independent of the employer, for purposes of this subparagraph, if he is entirely free of influence or con-trolled by the employer. For example, if the employer is a partnership, then a partner in such partnership, or a mem-ber of a partners family would not be considered independent of the em-ployer. Similarly, an employee of the employer would not be considered inde-pendent of the employer. For purposes of this subparagraph, the term trustee means, with respect to any trust for which there are two trustees who are independent of the employer, both of such trustees and, with respect to any trust for which there are more than two such independent trustees, a ma-jority of the trustees independent of the employer. (4)(i) Immediately following the mak-ing or renewal, as the case may be, the aggregate amount lent by the trust to the employer, without the receipt of adequate security must not exceed 25 percent of the value of all the assets of the trust. (ii) For purposes of paragraph (b)(4)(i) of this section, the determination as to whether any amount lent by the trust to the employer is a loan made without the receipt of adequate security shall be made without regard to section 503(e). Thus, if an employees trust makes a loan on January 2, 1959, to the employer without adequate security (but which loan is not considered as made without adquate security under section 503(e)), and if immediately after making such loan 10 percent of the value of all its assets is invested in such loan, then the trust may on that day invest not more than an additional 15 percent of its assets in a loan which VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00077 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15068 26 CFR Ch. I (4113 Edition) 1.5041 would be considered made without ade-quate security if it were not for the provisions of section 503(f). (iii) For purposes of paragraph (b)(4)(i) of this section, in determining the value of all the assets of the trust, there shall be used the fair market value of those assets on the day of the making or renewal. (c) Reasonable rate of interest. Section 503(f) only applies if, in addition to meeting the conditions described in paragraph (b) of this section, the loan bears a reasonable rate of interest when it is made, renewed, or, in the case of demand loans, during the period of its existence. (d) Change of terms of loan. A change in the terms of a loan (including a re-duction in the security for a loan) is considered as the making of a new loan. If such a new loan is not ade-quately secured, the requirements of section 503(f) must be met at the time the terms of the loan are changed for such section to be applicable to such new loan. (e) Effective date. (1) This section and section 503(f) are effective for taxable years ending after September 2, 1958, but only with respect to periods after such date. Thus, if a loan was made on or before September 2, 1958, without the receipt of adequate security and if, when such loan was made, it met all of the requirements of section 503(f) and this section, then the loan is not sub-ject to section 503(b)(1) after Sep-tember 2, 1958, and would not consitite a prohibited transaction after that date because of a lack of adequate se-curity. (2) See paragraph (b)(2) of 1.503(b)1 for the effective dates for application of the definition of adequate security. [T.D. 7428, 41 FR 34626, Aug. 16, 1976] 1.5041 Attempts to influence legisla-tion; certain organizations formerly described in section 501(c)(3) de-nied exemption. Section 504(a) and this section apply to an organization that is exempt from taxation at any time after October 4, 1976, as an organization described in section 501(c)(3), and that ceases to be described in that section because it (a) Is an action organization within the meaning of 1.501(c)(3)1(c)(3)(ii) or (iv), on account of activities occurring after October 4, 1976, or (b) Is denied exemption under the provisions of section 501(h) (see 1.501(h)3 or 56.49119). This section does not apply, however, to an organization that was described in section 501(h)(5) and 1.501(h)2(b)(3) (relating generally to churches) for its taxable year immediately preceding the first taxable year for which it is no longer an organization described in sec-tion 501(c)(3). An organization to which section 504(a) and this section apply shall not be treated as described in sec-tion 501(c)(4) at any time after the or-ganization ceases to be described in section 501(c)(3). Further, an organiza-tion denied treatment as an organiza-tion described in section 501(c)(4) under this section may not be treated as an organization described in section 501(c) other than as an organization described in section 501(c)(3). For rules relating to recognition of exemption after ex-emption is denied under section 501(h), 1.501(h)3(d). [T.D. 8308, 55 FR 35592, Aug. 31, 1990] 1.5042 Certain transfers made to avoid section 504(a). (a) Scope. Under section 504(b), a transfer described in paragraph (b) or (c) of this section to an organization exempt from tax under section 501(a) may result in loss of exemption by the transferee unless the Commissioner de-termines, under paragraph (e) of this section, that the original transfer did not effect an avoidance of section 504(a). For purposes of this section, the term transfer includes any use by, or for the benefit of, the recipient of the transfer, but does not include any transfer made for adequate and full consideration. (b) Transferor and transferee commonly controlled(1) Loss of exemption. A transfer is described in this paragraph (b) if it is described in paragraphs (b)(2) through (b)(6). The transferee of a transfer described in this paragraph will cease to be exempt from tax under section 501(a), unless the provisions of paragraph (e) of this section apply. (2) Transferor organization. A transfer is described in this paragraph (b)(2) only if it is from an organization that VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00078 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15069 Internal Revenue Service, Treasury 1.5042 (i) Is or was described in section 501(c)(3), but not in section 501(h)(5), and (ii) Is determined to be an action organization (as defined in 1.501(c)(3) 1(c)(3)(ii) or (iv)), or is denied exemp-tion from tax by reason of section 501(h) and either 1.501(h)3 or 56.4911 9. (3) Transferor and transferee commonly controlled. A transfer is described in this paragraph (b)(3) only if, at the time of the transfer or at any time dur-ing the transferees ten taxable years following the year in which the trans-fer was made, the transferee is con-trolled (directly or indirectly), as de-fined in paragraph (f) of this section, by the same person or persons who con-trol the transferor. (4) Time of transfer. A transfer is de-scribed in this paragraph (b)(4) only if the transfer is made (i) After the date that is 24 months before the earliest of the effective date of the determination under section 501(h) that the transferor is not ex-empt, the effective date of the Commis-sioners determination that the trans-feror is an action organization (as defined in 1.501(c)(3)(ii) or (iv)), or the date on which the Commissioner pro-poses to treat it as no longer described in section 501(c)(3), and (ii) Before the transferor again is rec-ognized as an organization described in section 501(c)(3). (5) Transferee. A transfer is described in this paragraph (b)(5) only if the transferee is exempt from tax under section 501(a) but the transferee is nei-ther (i) An organization described in sec-tion 501(c)(3), nor (ii) An organization described in sec-tion 401(a) to which the transferor con-tributes as an employer. (6) Amount of transfer. A transfer is described in this paragraph (b)(6) only if the amount of the transfer exceeds the lesser of 30 percent of the net fair market value of the transferors assets or 50 percent of the net fair market value of the transferees assets, com-puted immediately before the transfer. For purposes of this paragraph (b)(6) (i) The amount of a transfer by a transferor is the sum of the amounts transferred to any number of trans-ferees in any number of transfers, all of which are described in paragraphs (b)(2) through (b)(5) of this section, and the time of the transfer is the time of the first transfer so taken into account; and (ii) The amount of a transfer to a transferee is the sum of the amounts transferred by a transferor to the transferee in any number of transfers, all of which are described in para-graphs (b)(2) through (b)(5) of this sec-tion, and the time of the transfer is the time of the first transfer so taken into account. (c) Other transfers(1) Transfers in-cluded. A transfer is described in this paragraph (c) if it would be described in paragraph (b) of this section except that either (i) The amount of the transfer is less than the amount determined in para-graph (b)(6) of this section, or (ii) The transferor and transferee are not commonly controlled as described in paragraph (b)(3) of this section, or (iii) The transferee is an organization described in sections 501(c)(3) and 501(h)(4). (2) Loss of exemption. The transferee of a transfer described in this para-graph (c) will cease to be exempt under section 501(a) if the Commissioner de-termines on all the facts and cir-cumstances that the transfer effected an avoidance of section 504(a). In deter-mining whether a transfer effected an avoidance of section 504(a), the Com-missioner may consider whether the transferee engages, or has engaged, in attempts to influence legislation and may also consider any factors enumer-ated in paragraph (e) of this section. (d) Date of loss of exempt status. A transferee of a transfer described in paragraph (b), (c)(1)(ii), or (c)(1)(iii) of this section will cease to be exempt from tax under section 501(a) on the date that all requirements of para-graph (b), (c)(1)(ii), or (c)(1)(iii) (other than the determination by the Com-missioner) are satisfied. A transferee of a transfer described in paragraph (c)(1)(i) of this section will cease to be exempt from tax under section 501(a) on the date of the last transfer pre-ceding notification of the transferee that the Commissioner proposes to VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00079 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15070 26 CFR Ch. I (4113 Edition) 1.505(c)1T treat the transferee as other than an exempt organization. (e) Transfers not in avoidance of section 504(a). Notwithstanding paragraph (b) of this section, if, based on all the facts and circumstances, the Commissioner determines that a transfer described in paragraph (b) did not effect an avoid-ance of section 504(a), the transferee will not be denied exemption from tax by reason of section 504(b) and this sec-tion. In making the determination called for in the preceding sentence, the Commissioner may consider all rel-evant factors including: (1) Whether enforceable and effective conditions on the transfer preclude use of any of the transferred assets for any purpose that, if it were a substantial part of an organizations activities, would be inconsistent with exemption as an organization described in section 501(c)(3); (2) In the absence of conditions de-scribed in paragraph (e)(1) of this sec-tion, whether the transferred assets are used exclusively for purposes that are consistent with the transferors exemp-tion as an organization described in section 501(c)(3); (3) Whether the assets transferred would be describe in 53.4942(a)(2(c)(3) before, as well as after, the transfer if both the transferor and transferee were private foundations; (4) Whether and to what extent the transfer would satisfy the provisions of 1.5072(a) (7) and (8) if the transferor were a private foundation; (5) Whether all of the transferred as-sets have been expended during a pe-riod when the transferee was not con-trolled (directly or indirectly) by the same person or persons who controlled the transferor; and (6) Whether the entire amount of the transferred assets were in turn trans-ferred, before the close of the trans-ferees taxable year following the tax-able year in which the transferred as-sets were received, to one or more or-ganizations described in section 507(b)(1)(A) none of which are con-trolled (directly or indirectly) by the same persons who control either the original transferor or transferee. (f) Control. For purposes of section 504 and the regulations thereunder (1) The transferor will be presumed to control any organization with which it is affiliated within the meaning of 56.49117(a), or would be if both orga-nizations were described in section 501(c)(3), and (2) The transferee will be treated as controlled (directly of indirectly) by the same person or persons who control the transferor if the transferee would be treated as controlled under 53.4942(a)3(a)(3), for which purpose the transferor shall be treated as a pri-vate foundation. [T.D. 8308, 55 FR 35592, Aug. 31, 1990] 1.505(c)1T Questions and answers relating to the notification require-ment for recognition of exemption under paragraphs (9), (17) and (20) of Section 501(c) (temporary). Q1: What does section 505(c) of the Inter-nal Revenue Code provide? A1: Section 505(c) provides that an organi-zation will not be recognized as exempt under section 501(c)(9) as a voluntary em-ployees beneficiary association, under sec-tion 501(c)(17) as a trust forming part of a plan providing for the payment of supple-mental unemployment compensation bene-fits, or under section 501(c)(20) as a trust forming part of a qualified group legal serv-ices plan unless notification is given to the Internal Revenue Service. The notification required of a trust created pursuant to sec-tion 501(c)(20) and forming part of a qualified group legal services plan is set forth in Q&A 2. The notification required of an organiza-tion organized after July 18, 1984, and apply-ing for exempt status as an organization de-scribed in section 501(c) (9) or (17) is set forth in Q&A3 through Q&A8. The notification required of an organization organized on or before July 18, 1984, and claiming exemption as an organization described in section 501(c) (9) or (17) is set forth in Q&A9 through Q&A 11. However, an organization that has pre-viously notified the Internal Revenue Serv-ice of its claim to exemption under section 501(c) (9), (17), or (20) or its claim to exemp-tion under those sections pursuant to an-other provision of the Code, is not required, under section 505(c), to submit a renotifica-tion (See Q&A2 and Q&A12). SECTION 501(C)(20) TRUSTS Q2: What is the notice required of a trust created pursuant to section 501(c)(20) and forming part of a qualified group legal serv-ices plan under section 120? A2: (a) A trust claiming exemption as an organization described in section 501(c)(20) will be recognized as exempt if the exclusive VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00080 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15071 Internal Revenue Service, Treasury 1.505(c)1T function of the trust is to form part of a qualified group legal services plan or plans. Exemption of the trust under section 501(c)(20) will generally be dependent upon and coextensive with recognition of the plan as a qualified group legal services plan. Therefore, a trust organized pursuant to sec-tion 501(c)(20) after July 18, 1984, need not file a separate notice with the Internal Rev-enue Service of its claim to exemption be-cause the notice required by section 120(c)(4) will suffice for purposes of section 505(c), provided a copy of the trust instrument is filed with the Form 1024 submitted by the group legal services plan. If the trust instru-ment has not been filed with the Form 1024 submitted by the group legal services plan, the trust must comply with (and exemption will be dependent upon) the filing applicable to a trust organized on or before July 18, 1984. For the notice required and effective dates of exemption of a qualified group legal services plan under section 120, see 1.1203. (b) A trust organized on or before July 18, 1984, that claims exempt status as a trust de-scribed in section 501(c)(20) and that forms part of a qualified group legal services plan which has been recognized as exempt under section 120, must file a copy of its trust in-strument with the Internal Revenue Service before February 4, 1987. If a copy of the trust instrument is filed within the time provided, the trusts exemption will be recognized retroactively to the date the qualified group legal services plan was recognized as exempt under section 120. However, if a copy of the trust instrument is filed after the time pro-vided, exemption will be recognized only for the period after the copy of the trust instru-ment is filed with the Internal Revenue Service. See Q&A7 for a further discussion of date of filing. A trust that has previously filed a copy of its trust instrument with the Service need not refile that document. SECTION 501(C)(9) AND (17) ORGANIZATIONS ORGANIZED AFTER JULY 18, 1984 Q3: What is the notice required of an orga-nization or trust, organized after July 18, 1984, that is applying for recognition of tax exempt status under section 501(c) (9) or (17)? A3: An organization or trust that is orga-nized after July 18, 1984, will not be treated as described in paragraphs (9) or (17) of sec-tion 501(c), unless the organization notifies the Internal Revenue Service that it is ap-plying for recognition of exemption. In addi-tion, unless the required notice is given in the manner and within the time prescribed by these regulations, an organization will not be treated as exempt for any period be-fore the giving of the required notice. The notice is filed by submitting a properly com-pleted and executed Form 1024, Application for Recognition of Exemption Under Section 501(a) or for Determination Under Section 120 together with the additional informa-tion required under Q&A4 and Q&A5. The notice is filed with the district director for the key district in which the organizations principal place of business or principal office is located. The notice may be filed by either the plan administrator (as defined in section 414(g)) or the trustee. The Internal Revenue Service will not accept a Form 1024 for any organiza-tion or trust before such entity has been or-ganized. Q4: What information, in addition to the information required by Form 1024, must be submitted by an organization or trust seek-ing recognition of exemption under section 501(c) (9) or (17)? A4: A notice will not be considered com-plete unless, in addition to a properly com-pleted and executed Form 1024, the organiza-tion or trust submits a full description of the benefits available to participants under sec-tion 501(c) (9) or (17). Moreover, both the terms and conditions of eligibility for mem-bership and the terms and conditions of eli-gibility for benefits must be set forth. This information may be contained in a separate document, such as a plan document, or it may be contained in the creating document of the entity (e.g., the articles of incorporation or association, or a trust indenture). For bene-fits provided through a policy or policies of insurance, all such policies must be included with the notice. Where individual policies of insurance are provided to the participants, single exemplar copies, typical of policies generally issued to participants, are accept-able, provided they adequately describe all forms of insurance available to participants. In providing a full description of the benefits available, the benefits provided must be suf-ficiently described so that each benefit is definitely determinable. A benefit is defi-nitely determinable if the amount of the benefit, its duration, and the persons eligible to receive it are ascertainable from the plan document or other instrument. Thus, a ben-efit is not definitely determinable if the rules governing either its amount, its dura-tion, or its recipients are not ascertainable from the plan document or other instrument but are instead subject to the discretion of a person or committee. Likewise, a benefit is not definitely determinable if the amount for any individual is based upon a percentage share of any item that is within the discre-tion of the employer. However, a disability benefit will not fail to be considered defi-nitely determinable merely because the de-termination of whether an individual is dis-abled is made under established guidelines by an authorized person or committee. Q5: What is the notice required of collec-tively bargained plans? A5: If an organization or trust claiming exemption under section 501(c) (9) or (17) is VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00081 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15072 26 CFR Ch. I (4113 Edition) 1.505(c)1T organized and maintained pursuant to a col-lective bargaining agreement between em-ployee representatives and one or more em-ployer, only one Form 1024 is required to be filed for the organization or trust, regardless of the number of employers originally par-ticipating in the agreement. Moreover, once a Form 1024 is filed pursuant to a collective bargaining areement, an additional Form 1024 is not required to be filed by an em-ployer who thereafter participates in that agreement. When benefits are provided pur-suant to a collective bargaining agreement, the notice will not be considered complete unless, in addition to a properly completed and executed Form 1024, a copy of the collec-tive bargaining agreement is also submitted together with the additional information de-lineated in Q&A4. Q6: When must the required notice be filed by an organization or trust, organized after July 18, 1984, that seeks recognition of ex-emption under section 501(c) (9) or (17)? A6: An organization or trust applying for exemption must file the required notice by the later of February 4, 1987 or 15 months from the end of the month in which the orga-nization or trust was organized. An exten-sion of time for filing the required notice may be granted by the district director if the request is submitted before the end of the ap-plicable period and it is demonstrated that additional time is needed. Q7: What is the effective date of exemp-tion for a new organization or trust, orga-nized after July 18, 1984, that has submitted the required notice? A7: If the required notice is filed within the time provided by these regulations, the organizations exemption will be recognized retroactively to the date the organization was organized, provided its purpose, organi-zation and operation (including compliance with the applicable nondiscrimination re-quirements) during the period prior to the date of the determination letter are in ac-cordance with the applicable law. However, if the required notice is filed after the time provided by these regulations, exemption will be recognized only for the period after the application is filed with the Internal Revenue Service. The date of filing is the date of the United States postmark on the cover in which an exemption application is mailed or, if no postmark appears on the cover, the date the application is stamped as received by the Service. If an extension for filing the required notice has been granted to the organization, a notice filed on or before the last day specified in the extension will be considered timely and not the otherwise ap-plicable date under Q&A6. Q8: What is the effect on exemption of the filing of an incomplete notice? A8: Although a properly completed and executed Form 1024 together with the re-quired additional information (See Q&A4 and Q&A5) must be submitted to satisfy the notice required by section 505(c), the failure to file, within the time specified, all of the information necessary to complete such no-tice will not alone be sufficient to deny rec-ognition of exemption from the date of orga-nization to the date the completed informa-tion is submitted to the Service. If the no-tice which is filed with the Service within the required time is substantially complete, and the organization supplies the necessary additional information requested by the Service within the additional time allowed, the original notice will be considered timely. However, if the notice is not substantially complete or the additional information is not provided within the additional time al-lowed, exemption will be recognized only from the date of filing of the additional in-formation. SECTION 501(C)(9) AND (17) ORGANIZATIONS ORGANIZED ON OR BEFORE JULY 18, 1984 Q9: What is the notice required of an orga-nization or trust organized on or before July 18, 1984, that claims exempt status as an or-ganization described in section 501(c) (9) or (17)? A9: Section 505(c) provides a special rule for existing organizations and trusts orga-nized on or before July 18, 1984. Such an or-ganization or trust will not be treated as de-scribed in paragraphs (9) or (17) of section 501(c) unless the organization or trust noti-fies the Internal Revenue Service in the manner and within the time prescribed in these regulations that it is claiming exemp-tion under the particular section. The type of notice, the manner for filing that notice, and the additional information required is the same as that set forth in Q&A3 through Q&A5 for new organizations. Q10: When must the required notice be filed by an organization or trust organized on or before July 18, 1984? A10: An organization or trust organized on or before July 18, 1984, that claims exempt status as an organization described in sec-tion 501(c) (9) or (17), must file the required notice before February 4, 1987. An extension of time for filing the required notice may be granted by the district director if the re-quest is submitted before the due date of the notice and it is demonstrated that additional time is needed. Q11: What is the effective date of exemp-tion for an organization or trust organized on or before July 18, 1984, that has submitted the required notice? A11: If the required notice is filed within the time provided by these regulations, the organizations exemption will be recognized retroactively to the date the organization was organized, provided its purpose, organi-zation and operation (including compliance with the applicable nondiscrimination re-quirements) during the period prior to the VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00082 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15073 Internal Revenue Service, Treasury 1.5071 date of the determination letter are in ac-cordance with the applicable law. If, on the other hand, the required notice is filed after the time provided by these regulations, ex-emption will be recognized only for the pe-riod after the notice is received by the Inter-nal Revenue Service. See Q&A7 for a further discussion of date of filing. See also Q&A8 for the effect on exemption of a notice that has been timely filed but is incomplete. EXCEPTIONS TO NOTICE REQUIREMENT Q12: Are any organizations or trusts claiming recognition of exemption as an or-ganization described in section 501(c) (9) or (17) excepted from the notice requirement of section 505(c)? A12: An organization or trust that has previously notified the Internal Revenue Service of its claim to exemption by filing Form 1024 is not required, under section 505(c), to renotify the Service. Thus, an orga-nization that has filed a Form 1024 that is pending with the Service need not refile that form. Also, an organization that has received a ruling or determination letter from the Service recognizing its exemption from tax-ation need not submit the notification re-quired by section 505(c). [T.D. 8073, 51 FR 4330, Feb. 4, 1986] PRIVATE FOUNDATIONS 1.5071 General rule. (a) In general. Except as provided in 1.5072, the status of any organization as a private foundation shall be termi-nated only if: (1) Such organization notifies the dis-trict director of its intent to accom-plish such termination, or (2)(i) With respect to such organiza-tion, there have been either willful re-peated acts (or failures to act), or a willful and flagrant act (or failure to act), giving rise to liability for tax under chapter 42, and (ii) The Commissioner notifies such organization that, by reason of subdivi-sion (i) of this subparagraph, such or-ganization is liable for the tax imposed by section 507(c) and either such organization pays the tax imposed by section 507(c) (or any portion not abated under section 507(g)) or the entire amount of such tax is abated under section 507(g). (b) Termination under section 507(a)(1). (1) In order to terminate its private foundation status under paragraph (a)(1) of this section, an organization must submit a statement to the dis-trict director of its intent to terminate its private foundation status under sec-tion 507(a)(1). Such statement must set forth in detail the computation and amount of tax imposed under section 507(c). Unless the organization requests abatement of such tax pursuant to sec-tion 507(g), full payment of such tax must be made at the time the state-ment is filed under section 507(a)(1). An organization may request the abate-ment of all of the tax imposed under section 507(c), or may pay any part thereof and request abatement of the unpaid portion of the amount of tax as-sessed. If the organization requests abatement of the tax imposed under section 507(c) and such request is de-nied, the organization must pay such tax in full upon notification by the In-ternal Revenue Service that such tax will not be abated. For purposes of sub-title F of the Code, the statement de-scribed in this subparagraph, once filed, shall be treated as a return. (2) Termination of private foundation status under section 507(a)(1) does not relieve a private foundation, or any disqualified person with respect there-to, of liability for tax under chapter 42 with respect to acts or failures to act prior to termination or for any addi-tional taxes imposed for failure to cor-rect such acts or failures to act. See subparagraph (8) of this paragraph as to the possible imposition of transferee liability in cases not involving termi-nation of private foundation status. (3) In the case of an organization which has terminated its private foun-dation status under section 507(a) and continues in operation thereafter, if such organization wishes to be treated as described in section 501(c)(3), then pursuant to section 509(c) and 1.509(c) 1 such organization must apply for rec-ognition of exemption as an organiza-tion described in section 501(c)(3) in ac-cordance with the provisions of section 508(a). (4) See 53.49471(c)(7) of this chapter as to the application of section 507(a) to certain split-interest trusts. (5) For purposes of section 508(d)(1), the Internal Revenue Service shall make notice to the public (such as by publication in the Internal Revenue Bulletin) of any notice received from a private foundation pursuant to section VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00083 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15074 26 CFR Ch. I (4113 Edition) 1.5071 507(a)(1) or of any notice given to a pri-vate foundation pursuant to section 507(a)(2). (6) If a private foundation transfers all or part of its assets to one or more other private foundations (or one or more private foundations and one or more section 509(a) (1), (2), (3), or (4) or-ganizations) pursuant to a transfer de-scribed in section 507(b)(2) and 1.507 3(c), such transferor foundation will not have terminated its private founda-tion status under section 507(a)(1). See 1.5073, however, for the special rules applicable to private foundations par-ticipating in section 507(b)(2) transfers. (7) Neither a transfer of all of the as-sets of a private foundation nor a sig-nificant disposition of assets (as de-fined in 1.5073(c)(2)) by a private foundation (whether or not any portion of such significant disposition of assets is made to another private foundation) shall be deemed to result in a termi-nation of the transferor private founda-tion under section 507(a) unless the transferor private foundation elects to terminate pursuant to section 507(a)(1) or section 507(a)(2) is applicable. Thus, if a private foundation transfers all of its assets to one or more persons, but less than all of its net assets to one or more organizations described in sec-tion 509(a)(1) which have been in exist-ence and so described for a continuous period of 60 calendar months, for pur-poses of this paragraph such transferor foundation will not be deemed by rea-son of such transfer to have terminated its private foundation status under sec-tion 507 (a) or (b) unless section 507(a)(2) is applicable. Such foundation will continue to be treated as a private foundation for all purposes. For exam-ple, if a private foundation transfers all of its net assets to a section 509(a)(2) organization in 1971 and receives a be-quest in 1973, the bequest will be re-garded as having been made to a pri-vate foundation and the foundation will be subject to the provisions of chapter 42 with respect to such funds. If a private foundation makes a trans-fer of all of its net assets to a section 509(a) (2) or (3) organization, for exam-ple, it must retain sufficient income or assets to pay the tax imposed under section 4940 for that portion of its tax-able year prior to such transfer. For additional rules applicable to a trans-fer by a private foundation of all of its net assets to a section 509(a)(1) organi-zation which has not been in existence and so described for a continuous pe-riod of 60 calendar months, see 1.507 3(e). (8) If a private foundation makes a transfer described in subparagraph (7) of this paragraph and prior to, or in connection with, such transfer, liabil-ity for any tax under chapter 42 is in-curred by the transferor foundation, transferee liability may be applied against the transferee organization for payment of such taxes. For purposes of this subparagraph, liability for any tax imposed under chapter 42 for failure to correct any act or failure to act shall be deemed incurred on the date on which the act or failure to act giving rise to the initial tax liability oc-curred. (9) A private foundation which trans-fers all of its net assets is required to file the annual information return re-quired by section 6033, and the founda-tion managers are required to file the annual report of a private foundation required by section 6056, for the taxable year in which such transfer occurs. However, neither such foundation nor its foundation managers will be re-quired to file such returns for any tax-able year following the taxable year in which the last of any such transfers oc-curred, if at no time during the subse-quent taxable years in question the foundation has either legal or equitable title to any assets or engages in any activity. (c) Involuntary termination under sec-tion 507(a)(2). (1) For purposes of sec-tion 507(a)(2)(A), the term willful re-peated acts (or failures to act) means at least two acts or failures to act both of which are voluntary, conscious, and in-tentional. (2) For purposes of section 507(a)(2)(A), a willful and flagrant act (or failure to act) is one which is volun-tarily, consciously, and knowingly committed in violation of any provi-sion of chapter 42 (other than section 4940 or 4948(a)) and which appears to a reasonable man to be a gross violation of any such provision. (3) An act (or failure to act) may be treated as an act (or failure to act) by VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00084 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15075 Internal Revenue Service, Treasury 1.5072 the private foundation for purposes of section 507(a)(2) even though tax is im-posed upon one or more foundation managers rather than upon the founda-tion itself. (4) For purposes of section 507(a)(2), the failure to correct the act or acts (or failure or failures to act) which gave rise to liability for tax under any section of chapter 42 by the close of the correction period for such section may be a willful and flagrant act (or failure to act). (5) No motive to avoid the restric-tions of the law or the incurrence of any tax is necessary to make an act (or failure to act) willful. However, a foun-dations act (or failure to act) is not willful if the foundation (or a founda-tion manager, if applicable) does not know that it is an act of self-dealing, a taxable expenditure, or other act (or failure to act) to which chapter 42 ap-plies. Rules similar to the regulations under chapter 42 (see, for example, 53.49451(a)(2)(iii) of this chapter) shall apply in determining whether a foundation or a foundation manager knows that an act (or failure to act) is an act of self-dealing a taxable expend-iture or other such act (or failure to act). [T.D. 7233, 37 FR 28157, Dec. 21, 1972, as amended by T.D. 7290, 38 FR 31833, Nov. 19, 1973] 1.5072 Special rules; transfer to, or operation as, public charity. (a) Transfer to public charities(1) General rule. Under section 507(b)(1)(A) a private foundation, with respect to which there have not been either will-ful repeated acts (or failures to act) or a willful and flagrant act (or failure to act) giving rise to liability for tax under Chapter 42, may terminate its private foundation status by distrib-uting all of its net assets to one or more organizations described in sec-tion 170(b)(1)(A) (other than in clauses (vii) and (viii)) each of which has been in existence and so described for a con-tinuous period of at least 60 calendar months immediately preceding such distribution. Because section 507(a) does not apply to such a termination, a private foundation which makes such a termination is not required to give the notification described in section 507(a)(1). A private foundation that ter-minates its private foundation status under section 507(b)(1)(A) does not incur tax under section 507(c) and, therefore, no abatement of such tax under section 507(g) is required. (2) Effect of current ruling. A private foundation seeking to terminate its private foundation status pursuant to section 507(b)(1)(A) may rely on a rul-ing or determination letter issued to a potential distributee organization that such distributee organization is an or-ganization described in section 170(b)(1)(A)(i), 170(b)(1)(A)(ii), 170(b)(1)(A)(iii), 170(b)(1)(A)(iv), 170(b)(1)(A)(v), or 170(b)(1)(A)(vi) in ac-cordance with the provisions of 1.509(a)7. (3) Organizations described in more than one clause of section 170(b)(1)(A). For purposes of this paragraph and sec-tion 507(b)(1)(A), the parenthetical term other than in clauses (vii) and (viii) shall refer only to an organiza-tion that is described only in section 170(b)(1)(A)(vii) or section 170(b)(1)(A) (viii). Thus, an organization described in section 170(b)(1)(A)(i), 170(b)(1)(A)(ii), 170(b)(1)(A)(iii), 170(b)(1)(A)(iv), 170(b)(1)(A)(v), or 170(b)(1)(A)(vi) will not be precluded from being a dis-tributee described in section 507(b)(1)(A) merely because it also ap-pears to meet the description of an or-ganization described in section 170(b)(1)(A)(vii) or section 170(b)(1)(A)(viii). (4) Applicability of Chapter 42 to foun-dations terminating under section 507(b)(1)(A). An organization that ter-minates its private foundation status pursuant to section 507(b)(1)(A) will re-main subject to the provisions of Chap-ter 42 until the distribution of all of its net assets to distributee organizations described in section 507(b)(1)(A) has been completed. (5) Return required from organizations terminating private foundation status under section 507(b)(1)(A)(i) An organi-zation that terminates its private foun-dation status under section 507(b)(1)(A) is required to file a return under the provisions of section 6043(b). VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00085 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15076 26 CFR Ch. I (4113 Edition) 1.5072 (ii) An organization that terminates its private foundation status under sec-tion 507(b)(1)(A) is not required to com-ply with section 6104(d) for the taxable year in which such termination occurs. (6) Distribution of net assets. A private foundation will meet the requirement to distribute all of its net assets within the meaning of section 507(b)(1)(A) only if it transfers all of its right, title, and interest in and to all of its net assets to one or more organiza-tions referred to in section 507(b)(1)(A). (7) Effect of restrictions and conditions upon distributions of net assets(i) In general. In order to effectuate a trans-fer of all of its right, title, and inter-est in and to all of its net assets with-in the meaning of paragraph (a)(6) of this section, a transferor private foun-dation may not impose any material restriction or condition that prevents the transferee organization referred to in section 507(b)(1)(A) (herein some-times referred to as the public char-ity) from freely and effectively em-ploying the transferred assets, or the income derived therefrom, in further-ance of its exempt purposes. Whether or not a particular condition or restric-tion imposed upon a transfer of assets is material (within the meaning of this paragraph (a)(7)) must be determined from all of the facts and circumstances of the transfer. Some of the more sig-nificant facts and circumstances to be considered in making such a deter-mination are (A) Whether the public charity (in-cluding a participating trustee, custo-dian, or agent in the case of a commu-nity trust) is the owner in fee of the as-sets it receives from the private foun-dation; (B) Whether such assets are to be held and administered by the public charity in a manner consistent with one or more of its exempt purposes; (C) Whether the governing body of the public charity has the ultimate au-thority and control over such assets, and the income derived therefrom; and (D) Whether, and to what extent, the governing body of the public charity is organized and operated so as to be independent from the transferor. (ii) Independent governing body. As provided in paragraph (a)(7)(i)(D) of this section, one of the more signifi-cant facts and circumstances to be con-sidered in making the determination whether a particular condition or re-striction imposed upon a transfer of as-sets is material within the meaning of this paragraph (a)(7) is whether, and the extent to which, the governing body is organized and operated so as to be independent from the transferor. In turn, the determination as to such fac-tor must be determined from all of the facts and circumstances. Some of the more significant facts and cir-cumstances to be considered in making such a determination are (A) Whether, and to what extent, members of the governing body are comprised of persons selected by the transferor private foundation or dis-qualified persons with respect thereto or are themselves such disqualified per-sons; (B) Whether, and to what extent, members of the governing body are se-lected by public officials acting in their capacities as such; and (C) How long a period of time each member of the governing body may serve in such capacity. In the case of a transfer that is to a community trust, the community trust shall meet this paragraph (a)(7)(ii)(C) if (1) Its governing body is comprised of members who may serve a period of not more than ten consecutive years; and (2) Upon completion of a period of service (beginning before or after the date of transfer), no member may serve again within a period consisting of the lesser of five years or the number of consecutive years the member has im-mediately completed serving. (iii) Factors not adversely affecting de-termination. The presence of some or all of the following factors will not be con-sidered as preventing the transferee from freely and effectively employing the transferred assets, or the income derived therefrom, in furtherance of its exempt purposes (within the meaning of paragraph (a)(7)(i) of this section): (A) Name. The fund is given a name or other designation which is the same as or similar to that of the transferor private foundation or otherwise memo-rializes the creator of the foundation or his family. (B) Purpose. The income and assets of the fund are to be used for a designated VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00086 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15077 Internal Revenue Service, Treasury 1.5072 purpose or for one or more particular section 509(a)(1), section 509(a)(2), or section 509(a)(3) organization, and such use is consistent with the charitable, educational, or other basis for the ex-empt status of the public charity under section 501(c)(3). (C) Administration. The transferred assets are administered in an identifi-able or separate fund, some or all of the principal of which is not to be dis-tributed for a specified period, if the public charity (including a partici-pating trustee, custodian, or agent in the case of a community trust) is the legal and equitable owner of the fund and the governing body exercises ulti-mate and direct authority and control over such fund, as, for example, a fund to endow a chair at a university or a medical research fund at a hospital. In the case of a community trust, the transferred assets must be adminis-tered in or as a component part of the community trust within the meaning of 1.170A9(f)(11). (D) Restrictions on disposition. The transferor private foundation transfers property the continued retention of which by the transferee is required by the transferor if such retention is im-portant to the achievement of chari-table or other similar purposes in the community because of the peculiar fea-tures of such property, as, for example, where a private foundation transfers a woodland preserve which is to be main-tained by the public charity as an arbo-retum for the benefit of the commu-nity. Such a restriction does not in-clude a restriction on the disposition of an investment asset or the distribution of income. (iv) Adverse factors. The presence of any of the following factors will be considered as preventing the transferee from freely and effectively employing the transferred assets, or the income derived therefrom, in furtherance of its exempt purposes (within the meaning of paragraph (a)(7)(i) of this section): (A) Distributions. (1) With respect to distributions made after April 19, 1977, the transferor private foundation, a disqualified person with respect there-to, or any person or committee des-ignated by, or pursuant to the terms of an agreement with, such a person (hereinafter referred to as donor), re-serves the right, directly or indirectly, to name (other than by designation in the instrument of transfer of particular section 509(a)(1), section 509(a)(2), or section 509(a)(3) organizations) the per-sons to which the transferee public charity must distribute, or to direct the timing of such distributions (other than by direction in the instrument of transfer that some or all of the prin-cipal, as opposed to specific assets, not be distributed for a specified period) as, for example, by a power of appoint-ment. The IRS will examine carefully whether the seeking of advice by the transferee from, or the giving of advice by, any donor after the assets have been transferred to the transferee con-stitutes an indirect reservation of a right to direct such distributions. In any such case, the reservation of such a right will be considered to exist where the only criterion considered by the public charity in making a dis-tribution of income or principal from a donors fund is advice offered by the donor. Whether there is a reservation of such a right will be determined from all of the facts and circumstances, in-cluding, but not limited to, the factors contained in paragraphs (a)(7)(iv)(A)(2) and (a)(7)(iv)(A)(3) of this section. (2) The presence of some or all of the following factors will indicate that the reservation of a right to direct dis-tributions does not exist: (i) There has been an independent in-vestigation by the staff of the public charity evaluating whether the donors advice is consistent with specific chari-table needs most deserving of support by the public charity (as determined by the public charity). (ii) The public charity has promul-gated guidelines enumerating specific charitable needs consistent with the charitable purposes of the public char-ity and the donors advice is consistent with such guidelines. (iii) The public charity has instituted an educational program publicizing to donors and other persons the guidelines enumerating specific charitable needs consistent with the charitable purposes of the public charity. (iv) The public charity distributes funds in excess of amounts distributed from the donors fund to the same or VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00087 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15078 26 CFR Ch. I (4113 Edition) 1.5072 similar types of organizations or chari-table needs as those recommended by the donor. (v) The public charitys solicitations (written or oral) for funds specifically state that such public charity will not be bound by advice offered by the donor. (3) The presence of some or all of the following factors will indicate the res-ervation of a right to direct distribu-tions does exist: (i) The solicitations (written or oral) of funds by the public charity state or imply, or a pattern of conduct on the part of the public charity creates an expectation, that the donors advice will be followed. (ii) The advice of a donor (whether or not restricted to a distribution of in-come or principal from the donors trust or fund) is limited to distribu-tions of amounts from the donors fund, and the factors described in para-graph (a)(7)(iv)(A)(2)(i) or paragraph (a)(7)(iv)(A)(2)(ii) of this section are not present. (iii) Only the advice of the donor as to distributions of such donors fund is solicited by the public charity and no procedure is provided for considering advice from persons other than the donor with respect to such fund. (iv) For the taxable year and all prior taxable years the public charity fol-lows the advice of all donors with re-spect to their funds substantially all of the time. (B) Other action or withholding of ac-tion. The terms of the transfer agree-ment, or any expressed or implied un-derstanding, required the public char-ity to take or withhold action with re-spect to the transferred assets which is not designed to further one or more of the exempt purposes of the public char-ity, and such action or withholding of action would, if performed by the transferor private foundation with re-spect to such assets, have subjected the transferor to tax under Chapter 42 (other than with respect to the min-imum investment return requirement of section 4942(e)). (C) Assumption of leases, contractual obligations, or liabilities. The public charity assumes leases, contractual ob-ligations, or liabilities of the trans-feror private foundation, or takes the assets thereof subject to such liabil-ities (including obligations under com-mitments or pledges to donees of the transferor private foundation), for pur-poses inconsistent with the purposes or best interests of the public charity, other than the payment of the trans-ferors Chapter 42 taxes incurred prior to the transfer to the public charity to the extent of the value of the assets transferred. (D) Retention of investment assets. The transferee public charity is required by any restriction or agreement (other than a restriction or agreement im-posed or required by law or regulatory authority), express or implied, to re-tain any securities or other investment assets transferred to it by the private foundation. In a case where such trans-ferred assets consistently produce a low annual return of income, the IRS will examine carefully whether the transferee is required by any such re-striction or agreement to retain such assets. (E) Right of first refusal. An agree-ment is entered into in connection with the transfer of securities or other property which grants directly or indi-rectly to the transferor private founda-tion or any disqualified person with re-spect thereto a right of first refusal with respect to the transferred securi-ties or other property when and if dis-posed of by the public charity, unless such securities or other property was acquired by the transferor private foundation subject to such right of first refusal prior to October 9, 1969. (F) Relationships. An agreement is en-tered into between the transferor pri-vate foundation and the transferee pub-lic charity which establishes irrev-ocable relationships with respect to the maintenance or management of assets transferred to the public charity, such as continuing relationships with banks, brokerage firms, investment coun-selors, or other advisors with regard to the investments or other property transferred to the public charity (other than a relationship with a trustee, cus-todian, or agent for a community trust VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00088 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15079 Internal Revenue Service, Treasury 1.5072 acting as such). The transfer of prop-erty to a public charity subject to con-tractual obligations which were estab-lished prior to November 11, 1976, be-tween the transferor private founda-tion and persons other than disquali-fied persons with respect to such foun-dation will not be treated as prohibited under the preceding sentence, but only if such contractual obligations were not entered into pursuant to a plan to terminate the private foundation sta-tus of the transferor under section 507(b)(1)(A) and if the continuation of such contractual obligations is in the best interests of the public charity. (G) Other conditions. Any other condi-tion is imposed on action by the public charity which prevents it from exer-cising ultimate control over the assets received from the transferor private foundation for purposes consistent with its exempt purposes. (v) Examples. The provisions of this paragraph (a)(7) may be illustrated by the following examples: Example 1. The M Private Foundation transferred all of its net assets to the V Can-cer Institute, a public charity described in section 170(b)(1)(A)(iii). Prior to the transfer, Ms activities consisted of making grants to hospitals and universities to further research into the causes of cancer. Under the terms of the transfer, V is required to keep Ms assets in a separate fund and use the income and principal to further cancer research. Al-though the assets may be used only for a limited purpose, this purpose is consistent with and in furtherance of Vs exempt pur-poses, and does not prevent the transfer from being a distribution for purposes of section 507(b)(1)(A). Example 2. The N Private Foundation transferred all of its net assets to W Univer-sity, a public charity described in section 170(b)(1)(A)(ii). Under the terms of the trans-fer, W is required to use the income and prin-cipal to endow a chair at the university to be known as the John J. Doe Memorial Profes-sorship, named after Ns creator. Although the transferred assets are to be used for a specified purpose by W, this purpose is in fur-therance of Ws exempt educational pur-poses, and there are no conditions on invest-ment or reinvestment of the principal or in-come. The use of the name of the founda-tions creator for the chair is not a restric-tion which would prevent the transfer from being a distribution for purposes of section 507(b)(1)(A). Example 3. The O Private Foundation transferred all of its net assets to X Bank as trustee for the Q Community Trust, a com-munity trust that is a public charity de-scribed in section 170(b)(1)(A)(vi). Under the terms of the transfer, X is to hold the assets in trust for Q and is directed to distribute the income annually to the Y Church, a pub-lic charity described in section 170(b)(1)(A)(i). The distribution of income to Y Church is consistent with Qs exempt pur-poses. If the trust created by this transfer otherwise meets the requirements of 1.170A 9(f)(11) as a component part of the Q Commu-nity Trust, the assets transferred by O to X will be treated as distributed to one or more public charities within the meaning of sec-tion 507(b)(1)(A). The direction to distribute the income to Y Church meets the conditions of paragraph (a)(7)(iii)(B) of this section and will therefore not disqualify the transfer under section 507(b)(1)(A). Example 4. (i) The P Private Foundation transferred all of its net assets to Z Bank as trustee for the R Community Trust, a com-munity trust that is a public charity de-scribed in section 170(b)(1)(A)(vi). Under the terms of the transfer, Z is to hold the assets in trust for R and distribute the income to those public charities described in section 170(b)(1)(A)(i) through (b)(1)(A)(vi) that are designated by B, the creator of P. Rs gov-erning body has no authority during Bs life-time to vary Bs direction. Under the terms of the transfer, it is intended that Z retain the transferred assets in their present form for a period of 20 years, or until the date of Bs death if it occurs before the expiration of such period. Upon the death of B, R will have the power to distribute the income to such public charities as it selects and may dispose of the corpus as it sees fit. (ii) Under paragraph (a)(7)(iv)(A) or para-graph (a)(7)(iv)(D) of this section, as a result of the restrictions imposed with respect to the transferred assets, there has been no dis-tribution of all Ps net assets within the meaning of section 507(b)(1)(A) at the time of the transfer. In addition, P has not trans-ferred its net assets to a component part of R Community Trust, but rather to a separate trust described in 1.170A9(f)(12). (b) Operation as a public charity(1) In general. Under section 507(b)(1)(B), an organization can terminate its pri-vate foundation status if the organiza-tion (i) Meets the requirements of section 509(a)(1), section 509(a)(2) or section 509(a)(3) for a continuous period of 60 calendar months beginning with the first day of any taxable year that be-gins after December 31, 1969; (ii) In compliance with section 507(b)(1)(B)(ii) and paragraph (b)(3) of this section, properly notifies the IRS, in such manner as may be provided by VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00089 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15080 26 CFR Ch. I (4113 Edition) 1.5072 published guidance, publication, form or instructions, before the commence-ment of such 60-month period, that it is terminating its private foundation status; and (iii) Properly establishes imme-diately after the expiration of such 60- month period that such organization has complied with the requirements of section 509(a)(1), section 509(a)(2) or section 509(a)(3) during the 60-month period, in the manner described in paragraph (b)(4) of this section. (2) Relationship of section 507(b)(1)(B) to sections 507(a), 507(c), and 507(g). Be-cause section 507(a) does not apply to a termination described in section 507(b)(1)(B), a private foundations noti-fication that it is commencing a termi-nation pursuant to section 507(b)(1)(B) will not be treated as a notification de-scribed in section 507(a) even if the pri-vate foundation does not successfully terminate its private foundation status pursuant to section 507(b)(1)(B). A pri-vate foundation that terminates its private foundation status under section 507(b)(1)(B) does not incur tax under section 507(c) and, therefore, no abate-ment of such tax under section 507(g) is required. (3) Notification of termination. In order to comply with the requirements under section 507(b)(1)(B)(ii), an organization shall before the commencement of the 60-month period under section 507(b)(1)(B)(i) notify the IRS, in such manner as may be provided by pub-lished guidance, publication, form or instructions, of its intention to termi-nate its private foundation status. Such notification shall contain the fol-lowing information (i) The name and address of the pri-vate foundation; (ii) Its intention to terminate its pri-vate foundation status; (iii) The Code section under which it seeks classification (section 509(a)(1), section 509(a)(2) or section 509(a)(3)); (iv) If section 509(a)(1) is applicable, the clause of section 170(b)(1)(A) in-volved; (v) The date its regular taxable year begins; and (vi) The date of commencement of the 60-month period. (4) Establishment of termination. In order to comply with the requirements under section 507(b)(1)(B)(iii), an orga-nization shall within 90 days after the expiration of the 60-month period file such information with the IRS, in such manner as may be provided by pub-lished guidance, publication, form or instructions, as is necessary to make a determination as to the organizations status as an organization described under section 509(a)(1), section 509(a)(2) or section 509(a)(3) and the related reg-ulations. See paragraph (c) of this sec-tion as to the information required to be submitted under this paragraph (b)(4). (5) Incomplete information. The failure to supply, within the required time, all of the information required by para-graph (b)(3) or paragraph (b)(4) of this section is not alone sufficient to con-stitute a failure to satisfy the require-ments of section 507(b)(1)(B). If the in-formation that is submitted within the required time is incomplete and the or-ganization supplies the necessary addi-tional information at the request of the Commissioner within the addi-tional time period allowed by him, the original submission will be considered timely. (6) Application of special rules and fil-ing requirements. An organization that has terminated its private foundation status under section 507(b)(1)(B) is not required to comply with the special rules set forth in sections 508(a) and 508(b). Such organization is also not re-quired to file a return under the provi-sions of section 6043(b) by reason of ter-mination of its private foundation sta-tus under the provisions of section 507(b)(1)(B). (7) Extension of time to assess defi-ciencies. If a private foundation files a notification (described in paragraph (b)(3) of this section) that it intends to begin a 60-month termination pursuant to section 507(b)(1)(B) and does not file a request for an advance ruling pursu-ant to paragraph (d) of this section, such private foundation may file with the notification described in paragraph (b)(3) of this section a consent under section 6501(c)(4) to the effect that the period of limitation upon assessment under section 4940 for any taxable year within the 60-month termination pe-riod shall not expire prior to one year after the date of expiration of the time VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00090 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15081 Internal Revenue Service, Treasury 1.5072 prescribed by law for the assessment of a deficiency for the last taxable year within the 60-month period. Such con-sents, if filed, will ordinarily be accept-ed by the Commissioner. See paragraph (e)(3) of this section for an illustration of the procedure required to obtain a refund of the tax imposed by section 4940 in a case where such a consent is not in effect. (c) Sixty-month terminations(1) Meth-od of determining normal sources of sup-port. (i) In order to meet the require-ments of section 507(b)(1)(B) for the 60- month termination period as a section 509(a)(1) or section 509(a)(2) organiza-tion, an organization must meet the re-quirements of section 509(a)(1) or sec-tion 509(a)(2), as the case may be, for a continuous period of at least 60 cal-endar months. In determining whether an organization seeking status under section 509(a)(1) as an organization de-scribed in section 170(b)(1)(A)(iv) or section 170(b)(1)(A)(vi) or under section 509(a)(2) normally meets the require-ments set forth under such sections, support received in taxable years prior to the commencement of the 60-month period shall not be taken into consider-ation, except as otherwise provided in this section. (ii) For purposes of section 507(b)(1)(B), an organization will be considered to be a section 509(a)(1) or-ganization described in section 170(b)(1)(A)(vi) for a continuous period of 60 calendar months only if the orga-nization satisfies the provisions of 1.170A9(f), other than 1.170A 9(f)(4)(v), based upon aggregate data for such entire period. The calculation of public support shall be made over the period beginning with the date of the commencement of the 60-month period, and ending with the last day of the 60- month period. (iii) For purposes of section 507(b)(1)(B), an organization will be considered to be a section 509(a)(2) or-ganization only if such organization meets the support requirements set forth in sections 509(a)(2)(A) and 509(a)(2)(B) and the related regulations, other than 1.509(a)3(d), for the con-tinuous period of 60 calendar months prescribed under section 507(b)(1)(B). The calculation of public support shall be made over the period beginning with the date of the commencement of the 60-month period, and ending with the last day of the 60-month period. (2) Organizational and operational tests. In order to meet the requirements of section 507(b)(1)(B) for the 60-month termination period as an organization described in section 170(b)(1)(A)(i), 170(b)(1)(A)(ii), 170(b)(1)(A)(iii), 170(b)(1)(A)(iv), or 170(b)(1)(A)(v) or sec-tion 509(a)(3), as the case may be, an organization must meet the require-ments of the applicable provisions for a continuous period of at least 60 cal-endar months. For purposes of section 507(b)(1)(B), an organization will be considered to be such an organization only if it satisfies the requirements of the applicable provision (including with respect to section 509(a)(3), the or-ganizational and operational test set forth in section 509(a)(3)(A)) at the commencement of such 60-month pe-riod and continuously thereafter dur-ing such period. (d) Advance rulings for 60-month termi-nations(1) In general. An organization that files the notification required by section 507(b)(1)(B)(ii) that it is com-mencing a 60-month termination may obtain an advance ruling from the Commissioner that it can be expected to satisfy the requirements of section 507(b)(1)(B)(i) during the 60-month pe-riod. Such an advance ruling may be issued if the organization can reason-ably be expected to meet the require-ments of section 507(b)(1)(B)(i) during the 60-month period. The issuance of a ruling will be discretionary with the Commissioner. (2) Basic consideration. In determining whether an organization can reason-ably be expected (within the meaning of paragraph (d)(1) of this section) to meet the requirements of section 507(b)(1)(B)(i) for the 60-month period, the basic consideration is whether its organizational structure (taking into account any revisions made prior to the beginning of the 60-month period), current or proposed programs or activi-ties, actual or intended method of oper-ation, and current or projected sources of support are such as to indicate that the organization is likely to satisfy the requirements of section 509(a)(1), sec-tion 509(a)(2), or section 509(a)(3) and paragraph (c) of this section during the VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00091 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15082 26 CFR Ch. I (4113 Edition) 1.5072 60-month period. In making such a de-termination, all pertinent facts and circumstances shall be considered. (3) Reliance by grantors and contribu-tors. For purposes of sections 170, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522, grants or contribu-tions to an organization which has ob-tained a ruling referred to in this para-graph will be treated as made to an or-ganization described in section 509(a)(1), section 509(a)(2), or section 509(a)(3), as the case may be, until the IRS publishes notice that such advance ruling is being revoked (such as by pub-lication in the Internal Revenue Bul-letin). However, a grantor or contrib-utor may not rely on such an advance ruling if the grantor or contributor was responsible for, or aware of, the act or failure to act that resulted in the orga-nizations failure to meet the require-ments of section 509(a)(1), section 509(a)(2), or section 509(a)(3), or ac-quired knowledge that the IRS had given notice to such organization that its advance ruling would be revoked. Prior to the making of any grant or contribution which allegedly will not result in the grantees failure to meet the requirements of section 509(a)(1), section 509(a)(2), or section 509(a)(3), a potential grantee organization may re-quest a ruling whether such grant or contribution may be made without such failure. A request for such ruling may be filed by the grantee organiza-tion with the IRS. The issuance of such ruling will be at the sole discretion of the Commissioner. The organization must submit all information necessary to make a determination on the factors referred to in paragraph (d)(2) of this section. If a favorable ruling is issued, such ruling may be relied upon by the grantor or contributor of the par-ticular contribution in question for purposes of sections 170, 507, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522. (4) Reliance by organization. An orga-nization obtaining an advance ruling pursuant to this paragraph cannot rely on such a ruling. Consequently, if the organization does not pay the tax im-posed by section 4940 for any taxable year or years during the 60-month pe-riod, and it is subsequently determined that such tax is due for such year or years (because the organization did not in fact complete a successful termi-nation pursuant to section 507(b)(1)(B) and was not treated as an organization described in section 509(a)(1), section 509(a)(2), or section 509(a)(3) for such year or years), the organization is lia-ble for interest in accordance with sec-tion 6601 if any amount of tax under section 4940 has not been paid on or be-fore the last date prescribed for pay-ment. However, because any failure to pay such tax during the 60-month pe-riod (or prior to the revocation of such ruling) is due to reasonable cause, the penalty under section 6651 with respect to the tax imposed by section 4940 shall not apply. (5) Extension of time to assess defi-ciencies. The advance ruling described in paragraph (d)(1) of this section shall be issued only if such organizations re-quest for an advance ruling is filed with a consent under section 6501(c)(4) to the effect that the period of limita-tions upon assessment under section 4940 for any taxable year within the ad-vance ruling period shall not expire prior to one year after the date of the expiration of the time prescribed by law for the assessment of a deficiency for the last taxable year within the 60- month period. (e) Effect on grantors or contributors and on the organization itself(1) Effect of satisfaction of requirements for termi-nation; treatment during the termination period. In the event that an organiza-tion satisfies the requirements of sec-tion 507(b)(1)(B) for termination of its private foundation status during the continuous 60-month period, such orga-nization shall be treated for such en-tire 60-month period in the same man-ner as an organization described in sec-tion 509(a)(1), section 509(a)(2), or sec-tion 509(a)(3), as the case may be. (2) Failure to meet termination require-ments(i) In general. Except as other-wise provided in paragraphs (d) and (e)(2)(ii) of this section, any organiza-tion that fails to satisfy the require-ments of section 507(b)(1)(B) for termi-nation of its private foundation status during the continuous 60-month period shall be treated as a private foundation for the entire 60-month period, for pur-poses of sections 507 through 509 and Chapter 42, and grants or contributions VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00092 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15083 Internal Revenue Service, Treasury 1.5072 to such an organization shall be treat-ed as made to a private foundation for purposes of sections 170, 507(b)(1)(A), 4942, and 4945. (ii) Certain 60-month terminations. Not-withstanding paragraph (e)(2)(i) of this section, if an organization fails to sat-isfy the requirements of section 509(a)(1), section 509(a)(2), or section 509(a)(3) for the continuous 60-month period but does satisfy the require-ments of section 509(a)(1), section 509(a)(2), or section 509(a)(3), as the case may be, for any taxable year or years during such 60-month period, the organization shall be treated as a sec-tion 509(a)(1), section 509(a)(2), or sec-tion 509(a)(3) organization for such tax-able year or years, and grants or con-tributions made during such taxable year or years shall be treated as made to an organization described in section 509(a)(1), section 509(a)(2), or section 509(a)(3). In addition, sections 507 through 509 and Chapter 42 shall not apply to such organization for any tax-able year within such 60-month period for which it does meet such require-ments. For purposes of determining whether an organization satisfies the requirements of section 509(a)(1), sec-tion 509(a)(2), or section 509(a)(3) for any taxable year in the 60-month pe-riod, the calculation of public support shall be made over the period begin-ning with the date of the commence-ment of the 60-month period, and end-ing with the last day of the taxable year being tested. The organization shall not be treated as a section 509(a)(1) or section 509(a)(2) organiza-tion for any taxable year during the 60- month period solely by reason of hav-ing met a public support test for the preceding year. In addition, the transi-tion rules in 1.1709(f)(14)(iii) and 1.509(a)3(n)(iii) shall not apply. (iii) Aggregate tax benefit. For pur-poses of section 507(d), the organiza-tions aggregate tax benefit resulting from the organizations section 501(c)(3) status shall continue to be computed from the date from which such computation would have been made, but for the notice filed under section 507(b)(1)(B)(ii), except that any taxable year within such 60-month pe-riod for which such organization meets the requirements of section 509(a)(1), section 509(a)(2), or section 509(a)(3) shall be excluded from such computa-tions. (iv) Excess business holdings. See sec-tion 4943 and the related regulations for rules relating to decreases in a pri-vate foundations holdings in a busi-ness enterprise which are caused by the foundations failure to terminate its private foundation status after giving the notification for termination under section 507(b)(1)(B)(ii). (3) Example. The provisions of this paragraph (e) may be illustrated by the following example: Example 1. Y, a calendar year private foun-dation, notifies the IRS that it intends to terminate its private foundation status by converting into a publicly supported organi-zation described in section 170(b)(1)(A)(vi) and that its 60-month termination period will commence on January 1, 2010. Y does not obtain a ruling described in paragraph (d) of this section. Based upon its support for 2010, Y does not qualify as a publicly supported organization within the meaning of 1.170A 9(f) and this paragraph for 2010. Con-sequently, in order to avoid the risks of pen-alties and interest if Y fails to terminate within the 60-month period, Y files its 2010 return as a private foundation and pays the tax imposed by section 4940. Because a con-sent (described in paragraph (b)(7) of this section), which would prevent the period of limitations for all years in the 60-month pe-riod from expiring, is not in effect, in order to be able to file a claim for refund, Y and the IRS must agree to extend the period of limitation for all taxes imposed under Chap-ter 42 for 2010. Based on the aggregate data for the entire 60-month period (2010 through 2014), Y does qualify as a publicly-supported organization for the entire 60-month period. Consequently, Y is treated as a publicly-sup-ported organization for the entire 60-month period. Y files a claim for refund for the taxes paid under section 4940 for 2010, and such taxes are refunded. (f) Effective/applicability date(1) Ef-fective date. These regulations are effec-tive on September 8, 2011. (2) Applicability date. The regulations in this section shall apply to tax years beginning on or after January 1, 2008. For taxable years beginning after De-cember 31, 1969, and beginning before January 1, 2008, see 1.5072 (as con-tained in 26 CFR part 1 revised April 1, 2008). [T.D. 9549, 76 FR 55760, Sept. 8, 2011] VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00093 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15084 26 CFR Ch. I (4113 Edition) 1.5073 1.5073 Special rules; transferee foundations. (a) General rule. (1) For purposes of part II, subchapter F, chapter 1 of the Code, in the case of a transfer of assets of any private foundation to another private foundation pursuant to any liq-uidation, merger, redemption, recapi-talization, or other adjustment, organi-zation, or reorganization, the trans-feree organization shall not be treated as a newly created organization. Thus, in the case of a significant disposition of assets to one or more private foun-dations within the meaning of para-graph (c) of this section, the transferee organization shall not be treated as a newly created organization. A trans-feree organization to which this para-graph applies shall be treated as pos-sessing those attributes and character-istics of the transferor organization which are described in subparagraphs (2), (3), and (4) of this paragraph. (2)(i) A transferee organization to which this paragraph applies shall suc-ceed to the aggregate tax benefit of the transferor organization in an amount determined as follows: Such amount shall be an amount equal to the amount of such aggregate tax benefit multiplied by a fraction the numerator of which is the fair market value of the assets (less encumbrances) transferred to such transferee and the denominator of which is the fair market value of the assets of the transferor (less encum-brances) immediately before the trans-fer. Fair market value shall be deter-mined as of the time of the transfer. (ii) Notwithstanding subdivision (i) of this subparagraph, a transferee organi-zation which is not effectively con-trolled (within the meaning of 1.482 1(a)(3)), directly or indirectly, by the same person or persons who effectively control the transferor organization shall not succeed to an aggregate tax benefit in excess of the fair market value of the assets transferred at the time of the transfer. (iii) This subparagraph may be illus-trated by the following examples: Example 1. Pursuant to a transfer described in section 507(b)(2), F, a private foundation, transfers to G, a private foundation, all of its assets, which have a fair market value of $400,000. Immediately before the transfer Fs aggregate tax benefit was $200,000, and Gs aggregate tax benefit was $300,000. After the transfer Gs aggregate tax benefit is $500,000 ($200,000+$300,000). Example 2. Pursuant to a transfer described in section 507(b)(2), M, a private foundation, transfers all of its assets, which immediately prior to the transfer have a fair market value of $100,000. The assets were transferred to the following organizations at the fol-lowing fair market values (determined at the time of transfer) $40,000 to N, a private foun-dation, $30,000 to O, a private foundation, and $30,000 to P, an organization described in sec-tion 170(b)(1)(A)(vi). Immediately before the transfer Ms aggregate tax benefit was $50,000. Therefore, N succeeds to Ms aggre-gate tax benefit to the extent of $20,000 ($50,000$40,000/$100,000) and O succeeds to Ms aggregate tax benefit to the extent of $15,000 ($50,000$30,000/$100,000). The remaining $15,000 of Ms aggregate tax benefit is re-tained by M as M has not terminated under section 507. Example 3. Assume the same facts as in Ex-ample 2 except that the transfers were made as follows: M transferred $30,000 to N on Jan-uary 1, 1972, $40,000 to P on July 1, 1972, and $30,000 to O on December 31, 1972. Further, assume that the fair market value of the as-sets and the aggregate tax benefit do not change during 1972 and that O is not effec-tively controlled (directly or indirectly) by the same person or persons who effectively control M. N succeeds to Ms aggregate tax benefit to the extent of $15,000 ($50,000$30,000/$100,000). However, since $40,000 of the remaining $70,000 ($100,000$30,000) of assets of M was trans-ferred to P on July 1, 1972, immediately be-fore the transfer to O, the fair market value of the assets held by M is $30,000 ($70,000$40,000). On the other hand, because P is not a private foundation, Ms aggregate tax benefit immediately before the transfer to O remains $35,000 ($50,000$15,000). There-fore, before applying subdivision (ii) of this subparagraph, O would succeed to $35,000 ($35,000$30,000/$30,000) of Ms aggregate tax benefit. However, applying subdivision (ii) of this subparagraph since M transferred only $30,000 to O, O shall succeed to only $30,000 of Ms aggregate tax benefit. The remaining $5,000 ($35,000$30,000) of Ms aggregate tax benefit is retained by M as M has not termi-nated under section 507. (3) For purposes of section 507(d)(2), in the event of a transfer of assets de-scribed in section 507(b)(2), any person who is a substantial contributor (within the meaning of section 507(d)(2)) with respect to the transferor foundation shall be treated as a substantial contrib-utor with respect to the transferee foundation, regardless of whether such person meets the $5,000-two percent VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00094 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15085 Internal Revenue Service, Treasury 1.5073 test with respect to the transferee or-ganization at any time. If a private foundation makes a transfer described in section 507(b)(2) to two or more transferee private foundations, any person who is a substantial contributor with respect to the transferor founda-tion prior to such transfer shall be con-sidered a substantial contributor with re-spect to each transferee private foun-dation. (4) If a private foundation incurs li-ability for one or more of the taxes im-posed under chapter 42 (or any penalty resulting therefrom) prior to, or as a result of, making a transfer of assets described in section 507(b)(2) to one or more private foundations, in any case where transferee liability applies each transferee foundation shall be treated as receiving the transferred assets sub-ject to such liability to the extent that the transferor foundation does not sat-isfy such liability. (5) Except as provided in subpara-graph (9) of this paragraph, a private foundation is required to meet the dis-tribution requirements of section 4942 for any taxable year in which it makes a section 507(b)(2) transfer of all or part of its net assets to another private foundation. Such transfer shall itself be counted toward satisfaction of such requirements to the extent the amount transferred meets the requirements of section 4942(g). However, where the transferor has disposed of all of its as-sets, the recordkeeping requirements of section 4942(g)(3)(B) shall not apply during any period in which it has no assets. Such requirements are applica-ble for any taxable year other than a taxable year during which the trans-feror has no assets. (6) For purposes of section 4943(c) (4), (5), and (6), whenever a private founda-tion makes a section 507(b)(2) transfer of all or part of its net assets to an-other private foundation, the applica-ble period of time described in section 4943(c) (4), (5), or (6) shall include both the period during which the transferor foundation held such assets and the pe-riod during which the transferee foun-dation holds such assets. (7) Except as provided in subpara-graph (9) of this paragraph, where the transferor has disposed of all of its as-sets, during any period in which the transferor has no assets, section 4945 (d)(4) and (h) shall not apply to the transferee or the transferor with re-spect to any expenditure responsibility grants made by the transferor. How-ever, the exception contained in this subparagraph shall not apply with re-spect to any information reporting re-quirements imposed by section 4945 and the regulations thereunder for any year in which any such transfer is made. (8)(i) Except as provided in subdivi-sion (ii) of this subparagraph or sub-paragraph (6) or (9) of this paragraph or whenever a private foundation makes a transfer of assets described in section 507(b)(2) to one or more private founda-tions, the transferee foundation: (a) Will not be treated as being in ex-istence prior to January 1, 1970, with respect to any transferred assets; (b) Will not be treated as holding the transferred assets prior to January 1, 1970; and (c) Will not be treated as having en-gaged in, or become subject to, any transaction, lease, contract, or other obligation with respect to the trans-ferred assets prior to January 1, 1970. (ii) Notwithstanding subdivision (i) of this subparagraph, the provisions enu-merated in (a) through (g) of this sub-division shall apply to the transferee foundation with respect to the assets transferred to the same extent and in the same manner that they would have applied to the transferor foundation had the transfer described in section 507(b)(2) not been effected: (a) Section 4940(c)(4)(B) and the regu-lations thereunder with respect to basis of property, (b) Section 4942(f)(4) and the regula-tions thereunder with respect to dis-tributions of income, (c) Section 101(l)(2) of the Tax Reform Act of 1969 (83 Stat. 533), as amended by sections 1301 and 1309 of the Tax Re-form Act of 1976 (90 Stat. 1713, 1729), with respect to the provisions of sec-tion 4941, (d) Section 101(l)(3)(A) of the Tax Re-form Act of 1969 (83 Stat. 534) with re-spect to the provisions of section 4942, but only if the transferor qualified for the application of such section imme-diately before the transfer, and at least 85 percent of the fair market value of VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00095 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15086 26 CFR Ch. I (4113 Edition) 1.5073 the net assets of the transferee imme-diately after the transfer was received pursuant to the transfer, (e) Section 101(l)(3) (B) through (E) of the Tax Reform Act of 1969 (83 Stat. 534) with respect to the provisions of section 4942, (f) Section 101(l)(5) of the Tax Reform Act of 1969 (83 Stat. 535) with respect to the provisions of section 4945, and (g) Section 101(l)(6) of the Tax Reform Act of 1969 (83 Stat. 535) with respect to the provisions of section 508(e). (9) (i) If a private foundation trans-fers all of its net assets to one or more private foundations which are effec-tively controlled (within the meaning of 1.4821(a)(3)), directly or indirectly, by the same person or persons which effectively controlled the transferor private foundation, for purposes of chapter 42 (section 4940 et seq.) and part II of subchapter F of chapter 1 of the Code (sections 507 through 509) such a transferee private foundation shall be treated as if it were the transferor. However, where proportionality is ap-propriate, such a transferee private foundation shall be treated as if it were the transferor in the proportion which the fair market value of the assets (less encumbrances) transferred to such transferee bears to the fair market value of the assets (less encumbrances) of the transferor immediately before the transfer. (ii) Subdivision (i) of this subpara-graph shall not apply to the require-ments under sections 6033, 6056, and 6104 which must be complied with by the transferor private foundation, nor to the requirement under section 6043 that the transferor file a return with respect to its liquidation, dissolution, or termination. (iii) This subparagraph may be illus-trated by the following examples: Example 1. The trustees of X charitable trust, a private foundation, form the Y char-itable corporation, also a private foundation, in order to facilitate the conduct of their ac-tivities. The trustees of X are also the direc-tors of Y. Y has the same charitable purposes as X. All of the assets of X are transferred to Y, and Y continues to carry on Xs charitable activities. Under such circumstances, Y shall be treated as if it were X for the purposes of subdivision (i) of this subparagraph. Thus, for example, Y will be permitted to take ad-vantage of any special rules or savings provi-sions with respect to chapter 42 to the same extent as X could have if X had continued in existence. Example 2. A and B are the trustees of the P charitable trust, a private foundation, and are the only substantial contributors to P. On July 1, 1973, in order to facilitate accom-plishment of diverse charitable purposes, A and B create and control the R Foundation, the S Foundation and the T Foundation and transfer the net assets of P to R, S, and T. As of the end of 1973, P has an outstanding grant to Foundation W and has been required to exercise expenditure responsibility with re-spect to this grant under sections 4945 (d)(4) and (h). Under these circumstances, R, S, and T shall each be treated as if they are P in the proportion the fair market value of the assets transferred to each bears to the fair market value of the assets of P imme-diately before the transfer. Since R, S, and T are treated as P, absent a specific provision for exercising expenditure responsibility with respect to the grant to W, each of them is required to exercise expenditure responsi-bility with respect to such grant. If, as a part of the transfer to R, P assigned, and R as-sumed, Ps duties with respect to the expend-iture responsibility grant to W, only R would be required to exercise expenditure responsi-bility with respect to the grant to W. Since R, S, and T are treated as P rather than as recipients of expenditure responsibility grants, there are no expenditure responsibility re-quirements which must be exercised under sections 4945 (d)(4) and (h) with respect to the transfers of assets to R, S, and T. (10) For certain rules relating to fil-ing requirements where a private foun-dation has transferred all its net as-sets, see 1.5071(b)(9). (b) Status of transferee organization under section 507(b)(2). Since a transfer of assets pursuant to any liquidation, merger, redemption, recapitalization, or other adjustment, organization or reorganization to an organization not described in section 501(c)(3) (other than an organization described in sec-tion 509(a)(4)) or 4947 is a taxable ex-penditure under section 4945(d)(5), in order for such a transfer of assets not to be a taxable expenditure, it must be to an organization described in section 501(c)(3) (other than an organization described in section 509(a)(4)) or treat-ed as described in section 501(c)(3) under section 4947. See 53.49456(c)(3) of this chapter. Consequently, unless such a transferee is an organization de-scribed in section 509(a) (1), (2), or (3), the transferee is a private foundation and the rules of section 507(b)(2) and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00096 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15087 Internal Revenue Service, Treasury 1.5073 paragraph (a) of this section apply. On the other hand, if such a transfer of as-sets is made to a transferee organiza-tion which is not described in either section 501(c)(3) (other than an organi-zation described in section 509(a)(4)) or 4947, and in order to correct the mak-ing of a taxable expenditure, such as-sets are transferred to a private foun-dation, section 507(b)(2) and paragraph (a) of this section shall apply as if the transfer of assets had been made di-rectly to such private foundation. (c) Section 507(b)(2) transfers. (1) A transfer of assets is described in sec-tion 507(b)(2) if it is made by a private foundation to another private founda-tion pursuant to any liquidation, merg-er, redemption, recapitalization, or other adjustment, organization, or re-organization. This shall include any or-ganization or reorganization described in subchapter C of chapter 1. For pur-poses of section 507(b)(2), the terms other adjustment, organization, or reorga-nization shall include any partial liq-uidation or any other significant dis-position of assets to one or more pri-vate foundations, other than transfers for full and adequate consideration or distributions out of current income. For purposes of this paragraph, a dis-tribution out of current income shall include any distribution described in section 4942(h)(1) (A) and (B). (2) The term significant disposition of assets to one or more private foundations shall include any disposition for a tax-able year where the aggregate of: (i) The dispositions to one or more private foundations for the taxable year, and (ii) Where any disposition to one or more private foundations for the tax-able year is part of a series of related dispositions made during prior taxable years, the total of the related disposi-tions made during such prior taxable years, is 25 percent or more of the fair market value of the net assets of the foundation at the beginning of the tax-able year (in the case of subdivision (i) of this subparagraph) or at the begin-ning of the first taxable year in which any of the series of related dispositions was made (in the case of subdivision (ii) of this subparagraph). A significant disposition of assets may occur in a sin-gle taxable year (as in subdivision (i) of this subparagraph) or over the course of two or more taxable years (as in sub-division (ii) of this subparagraph). The determination whether a significant disposition has occurred through a se-ries of related distributions (within the meaning of subdivision (ii) of this sub-paragraph) will be made on the basis of all the facts and circumstances of the particular case. However, if one or more persons who are disqualified per-sons (within the meaning of section 4946) with respect to the transferor pri-vate foundation are also disqualified persons with respect to any of the transferee private foundations, such fact shall be evidence that the transfer is part of a series of related disposi-tions (within the meaning of subdivi-sion (ii) of this subparagraph). In the case of a series of related dispositions described in subdivision (ii) of this sub-paragraph, each transferee private foundation shall (on any date) be sub-ject to the provisions of section 507(b)(2) (with respect to all such dis-positions made to it on or before such date) to the extent described in para-graphs (a) and (b) of this section. (3) A private foundation which fails to meet the requirements of section 507(b)(1)(A) for a taxable year may be required to file a return under section 6043(b) by reason of a transfer of assets to one or more sections 509(a) (1), (2), or (3) organizations. Hence, such filing does not necessarily mean that a sec-tion 507(b)(2) transfer has occurred. See 1.60433(f)(1). (4) This paragraph applies to any sec-tion 507(b)(2) transfer made by a pri-vate foundation referred to in section 170(b)(1)(E) (i), (ii), or (iii). (5) The provisions of this paragraph may be illustrated by the following ex-amples: Example 1. M is a private foundation on the calendar year basis. It has net assets worth $100,000 as of January 1, 1971. In 1971, in addi-tion to distributions out of current income, M transfers $10,000 to N, $10,000 to O, and $10,000 to P. N, O, and P are all private foun-dations. Under subparagraph (2)(i) of this paragraph, M has made a significant disposi-tion of its assets in 1971 since M has disposed of more than 25 percent of its net assets (with respect to the fair market value of such assets as of January 1, 1971). M has therefore made section 507(b)(2) transfers within the meaning of this paragraph, and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00097 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15088 26 CFR Ch. I (4113 Edition) 1.5074 section 507(b)(2) applies to the transfers made to N, O, and P. Example 2. U, a tax-exempt private founda-tion on the calendar year basis, has net as-sets worth $100,000 as of January 1, 1971. As part of a series of related dispositions in 1971 and 1972, U transfers in 1971, in addition to distributions out of current income, $10,000 to private foundation X and $10,000 to private foundation Y, and in 1972, in addition to dis-tributions out of current income, U transfers $10,000 to private foundation Z. Under sub-paragraph (2)(ii) of this paragraph, U is treated as having made a series of related dispositions in 1971 and 1972. The aggregate of the 1972 disposition (under subparagraph (2)(i) of this paragraph) and the series of re-lated dispositions (under subparagraph (2)(ii) of this paragraph) is $30,000, which is more than 25 percent of the fair market value of Us net assets as of the beginning of 1971 ($100,000), the first year in which any such disposition was made. Thus, U has made a significant disposition of its assets and has made transfers described in section 507(b)(2). The provisions of paragraphs (a) and (b) of this section apply to each of the transferees as of the date on which it received assets from U. (d) Inapplicability of section 507(a) to section 507(b)(2) transfers. Unless a pri-vate foundation voluntarily gives no-tice pursuant to section 507(a)(1), a transfer of assets described in section 507(b)(2) will not constitute a termi-nation of the transferors private foun-dation status under section 507(a)(1). Such transfer must, nevertheless, sat-isfy the requirements of any pertinent provisions of chapter 42. See subpara-graphs (5) through (7) of paragraph (a) of this section. However, if such trans-fer constitutes an act or failure to act which is described in section 507(a)(2)(A), then such transfer will be subject to the provisions of section 507(a)(2) rather than section 507(b)(2). For example, X, a private nonoperating foundation, transfers all of its net as-sets to Y, a private operating founda-tion, in 1971. X does not file the notice referred to in section 507(a)(1) and the transfer does not constitute either a willful and flagrant act (or failure to act), or one of a series of willful re-peated acts (or failures to act), giving rise to liability for tax under chapter 42. Under these circumstances, the transfer is described in section 507(b)(2) and the provisions of paragraph (a) of this section apply with respect to Y. The private foundation status of X has not been terminated under section 507(a). (e) Transfers to certain section 509(a) (1), (2), or (3) organizations. If a private foundation transfers all or part of its assets to one or more organizations de-scribed in section 509(a) (1), (2), or (3) and, within a period of 3 years from the date of such transfers, one or more of the transferee organizations lose their section 509(a) (1), (2), or (3) status and become private foundations, then for purposes of this section, a transfer of assets within the meaning of paragraph (c) of this section to such an organiza-tion which becomes a private founda-tion will be treated as a transfer de-scribed in section 507(b)(2), and the pro-visions of paragraph (a) of this section shall be treated as applying to such a transferee organization from the date on which any such transfer was made to it. (f) Certain transfers made during sec-tion 507(b)(1)(B) terminations. If: (1) During the course of the 12-month or 60-month period described in section 507(b)(1)(B), a private foundation makes one or more transfers to one or more private foundations; (2) Such transfers are described in 1.5073(c)(1); and (3) Even though the transferor foun-dation thereafter meets the require-ments of section 507(b)(1)(B) then for purposes of this section, the provisions of 1.5072(e) shall not apply with respect to such transfers, and such transfers will be treated as trans-fers described in section 507(b)(2) and 1.5073 rather than as transfers from an organization described in section 509(a) (1), (2), or (3). [T.D. 7233, 37 FR 28158, Dec. 21, 1972; 38 FR 3189, Feb. 2, 1973, as amended by T.D. 7678, 45 FR 12415, Feb. 26, 1980] 1.5074 Imposition of tax. (a) General rule. Section 507(c) im-poses on each organization the private foundation status of which is termi-nated under section 507(a) a tax equal to the lower of: (1) The amount which such organiza-tion substantiates by adequate records (or other corroborating evidence which may be required by the Commissioner) as the aggregate tax benefit (as defined in section 507(d)) resulting from the VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00098 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15089 Internal Revenue Service, Treasury 1.5076 section 501(c)(3) status of such organi-zation, or (2) The value of the net assets of such organization. (b) Transfers not subject to section 507(c). Private foundations which make transfers described in section 507(b)(1)(A) or (2) are not subject to the tax imposed under section 507(c) with respect to such transfers unless the provisions of section 507(a) become ap-plicable. See 1.5071(b), 1.5072(a)(6) and 1.5073(d). [T.D. 7233, 37 FR 28161, Dec. 21, 1972] 1.5075 Aggregate tax benefit; in gen-eral. (a) General rule. For purposes of sec-tion 507(c)(1), the aggregate tax benefit resulting from the section 501(c)(3) sta-tus of any private foundation is the sum of: (1) The aggregate increases in tax under chapters 1, 11, and 12 (or the cor-responding provisions of prior law) which would have been imposed with respect to all substantial contributors to the foundation if deductions for all contributions made by such contribu-tors to the foundation after February 28, 1913, had been disallowed, (2) The aggregate increases in tax under chapter 1 (or the corresponding provisions of prior law) which would have been imposed with respect to the income of the private foundation for taxable years beginning after Decem-ber 31, 1912, if (i) it had not been ex-empt from tax under section 501(a) (or the corresponding provisions of prior law), and (ii) in the case of a trust, de-ductions under section 642(c) (or the corresponding provisions of prior law) had been limited to 20 percent of the taxable income of the trust (computed without the benefit of section 642(c) but with the benefit of section 170(b)(1)(A)), (3) The amount succeeded to from transferors under 1.5073(a) and sec-tion 507(b)(2), and (4) Interest on the increases in tax determined under subparagraphs (1), (2), and (3) of this paragraph from the first date on which each such increase would have been due and payable to the date on which the organization ceases to be a private foundation. (b) Contributions. In computing the amount of the aggregate increases in tax under subparagraph (1) of this para-graph, all deductions attributable to a particular contribution shall be in-cluded. For example, if a substantial contributor has taken deductions under sections 170 and 2522 (or the cor-responding provisions of prior law) with respect to the same contribution, the amount of each deduction shall be included in the computations under section 507(d)(1)(A). Accordingly, the aggregate tax benefit may exceed the fair market value of the property transferred. [T.D. 7233, 37 FR 28161, Dec. 21, 1972] 1.5076 Substantial contributor de-fined. (a) Definition(1) In general. Except as provided in subparagraph (2) of this paragraph, the term substantial contrib-utor means, with respect to a private foundation, any person (within the meaning of section 7701(a)(1)), whether or not exempt from taxation under sec-tion 501(a), who contributed or be-queathed an aggregate amount of more than $5,000 to the private foundation, if such amount is more than 2 percent of the total contributions and bequests received by the private foundation be-fore the close of the taxable year of the private foundation in which a contribu-tion or bequest is received by the foun-dation from such person. In the case of a trust, the term substantial contributor also means the creator of the trust. Such term does not include a govern-mental unit described in section 170(c)(1). (2) Special rules. For purposes of sec-tions 170(b)(1)(E)(iii), 507(d)(1), 508(d), 509(a) (1) and (3), and chapter 42, the term substantial contributor shall not include an organization which is de-scribed in section 509(a) (1), (2), or (3) or any other organization which is wholly owned by such section 509(a) (1), (2), or (3) organization. Furthermore, taking section 4941 (relating to taxes on self- dealing) in context, it would unduly re-strict the activities of private founda-tions if the term substantial contributor were to include any section 501(c)(3) or-ganizations. It was not intended, for VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00099 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15090 26 CFR Ch. I (4113 Edition) 1.5076 example, that a large grant for chari-table purposes from one private foun-dation to another world forever pre-clude the latter from making any grants to, or otherwise dealing with, the former. Accordingly, for purposes of section 4941 only, the term substan-tial contributor shall not only include any organization which is described in section 501(c)(3) (other than an organi-zation described in section 509(a)(4)). (b) Determination of substantial con-tributor(1) In general. In determining under paragraph (a) of this section whether the aggregate of contributions and bequests from a person exceeds 2 percent of the total contributions and bequests received by a private founda-tion, both the total of such amounts received by the private foundation, and the aggregate of such amounts contrib-uted and bequeathed by such person, shall be determined as of the last day of each taxable year commencing with the first taxable year ending after Oc-tober 9, 1969. Generally, under section 507(d)(2) and this section, except for purposes of valuation under section 507(d)(2)(B)(i), all contributions and be-quests made before October 9, 1969, are deemed to have been made on October 9, 1969. For purposes of section 509(a)(2) and the support test described in 1.509(a)3(c), contributions and be-quests before October 9, 1969, will be taken into account in the year when actually made. For example, in the case of a contribution or bequest of $6,000 in 1967, such contribution or be-quest shall be treated as made by a substantial contributor in 1967 for pur-poses of section 509(a)(2) and 1.509(a) 3(c) if such person met the $5,0002 percent test as of December 31, 1967, and December 31, 1969 (in the case of a calendar year accounting period). Al-though the determination of the per-centage of total contributions and be-quests represented by a given donors contributions and bequests is not made until the end of the foundations tax-able year, a donor is a substantial con-tributor as of the first date when the foundation received from him an amount sufficient to make him a sub-stantial contributor. Except as other-wise provided in this subparagraph, such amount is treated for all purposes as made by a substantial contributor. Thus, the total contributions and be-quests received by the private founda-tion from all persons, and the aggre-gate contributions and bequests made by a particular person, are to be deter-mined as of December 31, 1969 (in the case of a calendar year organization which was in existence on that date), and the amounts included in each re-spective total would be all contribu-tions and bequests received by the or-ganization on or before that date, and all contributions and bequests made by the person on or before that date. Thereafter, a similar determination is to be made with respect to such private foundation as of the end of each of its succeeding taxable years. Status as a substantial contributor, however, will date from the time when the donor first met the $5,000 and 2 percent test. Once a person is a substantial contrib-utor with respect to a private founda-tion, he remains a substantial contrib-utor even though he might not be so classified if a determination were first made at some later date. For instance, even though the aggregate contribu-tions and bequests of a person become less than 2 percent of the total received by a private foundation (for example, because of subsequent contributions and bequests by other persons), such person remains a substantial contrib-utor with respect to the foundation. (2) Examples. The provisions of para-graph (a) of this section and this para-graph (b) may be illustrated by the fol-lowing examples: Example 1. On January 1, 1968, A, an indi-vidual, gave $4,500 to M, a private foundation on a calendar year basis. On June 1, 1969, A gave M the further sum of $1,500. Throughout its existence, through December 31, 1969, M has received $250,000 in contributions and be-quests from all sources. As of June 1, 1969, A is a substantial contributor to M for pur-poses of section 509(a)(2). Example 2. On September 9, 1966, B, an indi-vidual, gave $3,500 to N, a private foundation on a calendar year basis. On March 15, 1970, B gave N the further sum of $3,500. Through-out its existence, through December 31, 1970, N has received $200,000 in contributions and bequests from all sources. B is a substantial contributor to N as of March 15, 1970, since that is the first date on which his contribu-tions met the 2 percent-$5,000 test. Example 3. On July 21, 1964, X, a corpora-tion, gave $2,000 to O, a private foundation on a calendar year basis. As of December 31, VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00100 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15091 Internal Revenue Service, Treasury 1.5077 1969, O had received $150,000 from all sources. On September 17, 1970, X gave O the further sum of $3,100. Through September 17, 1970, O had received $245,000 from all sources as total contributions and bequests. Between Sep-tember 17, 1970, and December 31, 1970, how-ever, O received $50,000 in contributions and bequests from others. X is not a substantial contributor to O, since Xs contributions to O were not more than 2 percent of the total contributions and bequests received by O by December 31, 1970, the end of Os taxable year, even though Xs contributions met that test at one point during the year. Example 4. On September 16, 1970, C, an in-dividual, gave $10,000 to P, a private founda-tion on a calendar year basis. Throughout its existence, and through December 31, 1970, the close of its taxable year, P had received a total of $100,000 in contributions and be-quests. On January 3, 1971, P received a be-quest of $1 million. C is a substantial con-tributor to P since he was a substantial con-tributor as of September 16, 1970, and there-fore remains one even though he no longer meets the 2-percent test on a later date after the end of the taxable year of the foundation in which he first became a substantial con-tributor. (c) Special rules(1) Contributions de-fined. The term contribution shall, for purposes of section 507(d)(2), have the same meaning as such term has under section 170(c) and also include be-quests, legacies, devises, and transfers within the meaning of section 2055 or 2106(a)(2). Thus, for purposes of section 507(d)(2), any payment of money or transfer of property without adequate consideration shall be considered a con-tribution. Where payment is made or property transferred as consideration for admissions, sales of merchandise, performance of services, or furnishing of facilities to the donor, the qualifica-tion of all or any part of such payment or transfer as a contribution under sec-tion 170(c) shall determine whether and to what extent such payment or trans-fer constitutes a contribution under sec-tion 507(d)(2). (2) Valuation of contributions and be-quests. Each contribution or bequest to a private foundation shall be valued at fair market value when actually re-ceived by the private foundation. (3) Contributions and bequests by a spouse. An individual shall be consid-ered, for purposes of this section, to have made all contributions and be-quests made by his spouse during the period of their marriage. Thus, for ex-ample, where W contributed $500,000 to P, a private foundation, in 1941 and that amount exceeded 2 percent of the total contributions received by P as of the end of Ps first taxable year ending after October 9, 1969, H (Ws spouse at the time of the 1941 gift) is considered to have made such contribution (even if W died prior to October 9, 1969, or their marriage was otherwise termi-nated prior to such date). Similarly, any bequest or devise shall be treated as having been made by the decedents surviving spouse. [T.D. 7241, 37 FR 28743, Dec. 29, 1972; 38 FR 24206, Sept. 6, 1973] 1.5077 Value of assets. (a) In general. For purposes of section 507(c), the value of the net assets shall be determined at whichever time such value is higher: (1) The first day on which action is taken by the organization which cul-minates in its ceasing to be a private foundation, or (2) The date on which it ceases to be a private foundation. (b) Valuation dates. (1) In the case of a termination under section 507(a)(1), the date referred to in paragraph (a)(1) of this section shall be the date on which the terminating foundation gives the notification described in sec-tion 507(a)(1). (2) In the case of a termination under section 507(a)(2), the date referred to in paragraph (a)(1) of this section shall be the date of occurrence of the willful and flagrant act (or failure to act) or the first of the series of willful re-peated acts (or failures to act) giving rise to liability for tax under chapter 42 and the imposition of tax under sec-tion 507(a)(2). (c) Fair market value. For purposes of this section, fair market value shall be determined pursuant to the provisions of 53.4942(a)2(c)(4) of this chapter. (d) Net assets. For purposes of section 507 and the regulations thereunder, the term net assets shall mean the gross as-sets of a private foundation reduced by all liabilities of the foundation, includ-ing appropriate estimated and contin-gent liabilities. Thus, a determination of net assets may reflect reductions for any liability or contingent liability for VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00101 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15092 26 CFR Ch. I (4113 Edition) 1.5078 tax imposed upon the private founda-tion under chapter 42 with respect to acts or failures to act prior to termi-nation, for any liability or contingent liability for failures to correct such acts or failures to act, or for any liabil-ity or estimated or contingent liability with respect to expenses associated with winding up the organization. If a private foundations determination of net assets reflects any reduction for any estimated or contingent liability, such private foundation must estab-lish, to the satisfaction of the Commis-sioner, the reasonableness of such re-duction. If the amount of net assets re-flects a reduction for any estimated or contingent liability, at the earlier of the final determination of the contin-gency or the termination of a reason-able time, any excess of the amount by which the gross assets was reduced over the amount of the liability shall be treated in the same manner as if such excess had been considered part of the net assets. [T.D. 7233, 37 FR 28161, Dec. 21, 1972] 1.5078 Liability in case of transfers. For purposes of determining liability for the tax imposed under section 507(c) in the case of assets transferred by the private foundation, such tax shall be deemed to have been imposed on the first day on which action is taken by the organization which culminates in its ceasing to be a private foundation. If an organizations private foundation status is terminated under section 507(a)(2), the first day on which action is taken which culminates in its ceas-ing to be a private foundation (within the meaning of section 507(f)) shall be the date described in 1.5077(b)(2). If an organization terminates its private foundation status under section 507(a)(1), the first day on which action is taken which culminates in its ceas-ing to be a private foundation (within the meaning of section 507(f)) shall be the date described in 1.5077(b)(1). [T.D. 7233, 37 FR 28161, Dec. 21, 1972] 1.5079 Abatement of taxes. (a) General rule. The Commissioner may at his discretion abate the unpaid portion of the assessment of any tax imposed by section 507(c), or any liabil-ity in respect thereof, if: (1) The private foundation distributes all of its net assets to one or more or-ganizations described in section 170(b)(1)(A) (other than in clauses (vii) or (viii)) each of which has been in ex-istence and so described for a contin-uous period of at least 60 calendar months, or (2) Effective assurance is given to the Commissioner in accordance with para-graphs (b) and (c) of this section that the assets of the organization which are dedicated to charitable purposes will, in fact, be used for charitable pur-poses The provisions of 1.5072(a) (2), (3), and (7) shall apply to distributions under subparagraph (1) of this paragraph. Since section 507(g) provides only for the abatement of tax imposed under section 507(c), no tax imposed under any provision of chapter 42 shall be abated under section 507(g). Where the taxpayer files a petition with the Tax Court with respect to a notice of defi-ciency regarding any tax under section 507(c), such tax shall be treated as hav-ing been assessed for the purposes of abatement of such tax under section 507(g) and the regulations thereunder. (b) State proceedings. (1) The Commis-sioner may at his discretion abate the unpaid portion of the assessment of any tax imposed by section 507(c), or any liability in respect thereof, under the procedures outlined in subpara-graphs (2) and (3) of this paragraph. Such tax may not be abated by the Commissioner unless he determines that corrective action as defined in paragraph (c) of this section has been taken. The Commissioner may not abate by reason of section 507(g) any amount of such tax which has already been collected since only the unpaid portion thereof can be abated. (2) The appropriate State officer shall have 1 year from the date of noti-fication prescribed in section 6104(c) that a notice of deficiency of tax im-posed under section 507(c) has been issued with respect to a foundation, to advise the Commissioner that correc-tive action has been initiated pursuant VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00102 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15093 Internal Revenue Service, Treasury 1.5079 to State law as may be ordered or ap-proved by a court of competent juris-diction. Corrective action may be initi-ated either by the appropriate State of-ficer or by an organization described in section 509(a) (1), (2), or (3) which is a beneficiary of the private foundation and has enforceable rights against such foundation under State law. Copies of all pleadings and other documents filed with the court at the initial stages of the proceedings shall be attached to the notification made by the State offi-cer to the Commissioner. Prior to noti-fication by the appropriate State offi-cer that corrective action has been ini-tiated, the Commissioner shall follow those procedures which would apply with respect to the assessment and col-lection of the tax imposed under sec-tion 507(c) without regard to section 507(g)(2). Subsequent to notification by the appropriate State officer that cor-rective action has been initiated, the Commissioner shall suspend action with respect to the assessment or col-lection of tax imposed under section 507(c) until notified of the final deter-mination of such corrective action, as long as any such resulting delay does not jeopardize the collection of such tax and does not cause collection to be barred by operation of law or any rule of law. In any case where collection of such tax is about to be barred by oper-ation of section 6502 and the Commis-sioner has not been advised of the final determination of corrective action, the Commissioner should make every ef-fort to obtain appropriate agreements with the foundation subject to such tax to extend the period of limitations under section 6502(a)(2). Where such agreements are obtained, action with respect to the assessment and collec-tion of such tax may be suspended to the extent not inconsistent with this subparagraph. (3) Upon receipt of certification from the appropriate State officer that ac-tion has been ordered or approved by a court of competent jurisdiction, the Commissioner may abate the unpaid portion of the assessment of tax im-posed by section 507(c), or any liability in respect thereof, if in his judgment such action is corrective action within the meaning of paragraph (c) of this section. In the event that such action is not corrective action, the Commis-sioner may in his discretion again sus-pend action on the assessment and col-lection of such tax until corrective ac-tion is obtained, or if in his judgment corrective action cannot be obtained, he may resume the assessment and col-lection of such tax. (c) Corrective action. The term correc-tive action referred to in paragraph (b) of this section means vigorous enforce-ment of State laws sufficient to assure implementation of the provisions of chapter 42 and insure that the assets of such private foundation are preserved for such charitable or other purposes specified in section 501(c)(3). Except where assets of the terminated private foundation are transferred to an orga-nization described in section 509(a) (1) through (4) the State is required to take such action to assure that the provisions of section 508(e)(1) (A) and (B) are applicable to the terminated foundation (or any transferee) with re-spect to such assets as if such organiza-tion were a private foundation. Thus, the governing instrument of such orga-nization must include provisions with respect to such assets: (1) Requiring its income therefrom for each taxable year to be distributed at such time and in such manner as not to subject such organization to tax under section 4942 (as if the organiza-tion were a private foundation), (2) Prohibiting such organization from engaging in any act of self-deal-ing (as defined in section 4941(d) as if the organization were a private founda-tion), (3) Prohibiting such organization from retaining any excess business holdings (as defined in section 4943(c) as if the organization were a private foundation), (4) Prohibiting such organization from making any investments in such manner as to subject such organization to tax under section 4944 (as if the or-ganization were a private foundation), and (5) Prohibiting such organization from making any taxable expenditures (as defined in section 4945(d) as if the organization were a private founda-tion). Consequently, in cases where the preceding sentence applies, although VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00103 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15094 26 CFR Ch. I (4113 Edition) 1.5081 the private foundation status of an or-ganization is terminated for tax pur-poses, it is contemplated that its sta-tus under State law would remain un-changed, because the tax under section 507(c) has been abated solely because the Commissioner has been given effec-tive assurance that there is vigorous enforcement of State laws sufficient to assure implementation of the provi-sions of chapter 42. Therefore, in such a case while chapter 42 will not apply to acts occurring subsequent to termi-nation which previously would have re-sulted in the imposition of tax under chapter 42, it is contemplated that there will be vigorous enforcement of State laws (including laws made appli-cable by the provisions in the gov-erning instrument) with respect to such acts. Notwithstanding the pre-ceding three sentences, no amendment to the organizations governing instru-ment is necessary where there are pro-visions of State law which have the ef-fect of requiring a terminated private foundation to which the rules of sub-paragraphs (1) through (5) of this para-graph apply to be subject to such rules whether or not there are such provi-sions in such terminated private foun-dations governing instrument. [T.D. 7233, 37 FR 28161, Dec. 21, 1972] 1.5081 Notices. (a) New organizations must notify the Commissioner that they are applying for recognition of section 501(c)(3) status(1) In general. Except as provided in sub-paragraph (3) of this paragraph, an or-ganization that is organized after Octo-ber 9, 1969, will not be treated as de-scribed in section 501(c)(3): (i) Unless such organization has given the Commissioner notice in the manner prescribed in subparagraph (2) of this paragraph; or (ii) For any period before the giving of such notice, unless such notice is given in the manner and within the time prescribed in subparagraph (2) of this paragraph No organization shall be exempt from taxation under section 501(a) by reason of being described in section 501(c)(3) whenever such organization is not treated as described in section 501(c)(3) by reason of section 508(a) and this paragraph. See section 508(d)(2)(B) and 1.5082(b) regarding the deductibility of charitable contributions to an orga-nization during the period such organi-zation is not exempt under section 501(a) as an organization described in section 501(c)(3) by reason of failing to file a notice under section 508(a) and this subparagraph. See also 1.508 2(b)(1)(viii) regarding the deductibility of charitable contributions to trusts described in section 4947(a)(1). (2) Filing of notice. (i) For purposes of subparagraph (1) of this paragraph, ex-cept as provided in subparagraph (3) of this paragraph, an organization seek-ing exemption under section 501(c)(3) must file the notice described in sec-tion 508(a) within 15 months from the end of the month in which the organi-zation was organized, or before March 22, 1973, whichever comes later. Such notice is filed by submitting a properly completed and executed Form 1023, ex-emption application. Notice should be filed with the district director. A re-quest for extension of time for the fil-ing of such notice should be submitted to such district director. Such request may be granted if it demonstrates that additional time is required. (ii) Although the information re-quired by Form 1023 must be submitted to satisfy the notice required by this section, the failure to supply, within the required time, all of the informa-tion required to complete such form is not alone sufficient to deny exemption from the date of organization to the date such complete information is sub-mitted by the organization. If the in-formation which is submitted within the required time is incomplete, and the organization supplies the necessary additional information at the request of the Commissioner within the addi-tional time period allowed by him, the original notice will be considered time-ly. (iii) For purposes of subdivision (i) of this subparagraph and paragraph (b)(2)(i) of this section, an organization shall be considered organized on the date it becomes an organization de-scribed in section 501(c)(3) (determined without regard to section 508(a)). VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00104 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15095 Internal Revenue Service, Treasury 1.5081 (iv) Since a trust described in section 4947(a)(2) is not an organization de-scribed in section 501(c)(3), it is not re-quired to file a notice described in sec-tion 508(a). (v) For the treatment of community trusts, and the trusts or funds com-prising them, under section 508, see the special rules under 1.170A9(e). (vi) A foreign organization shall, for purposes of section 508, be treated in the same manner as a domestic organi-zation, except that section 508 shall not apply to a foreign organization which is described in section 4948(b). (3) Exceptions from notice. (i) Para-graphs (a) (1) and (2) of this section are inapplicable to the following organiza-tions: (a) Churches, interchurch organiza-tions of local units of a church, conven-tions or associations of churches, or in-tegrated auxiliaries of a church. See 1.60332(h) regarding the definition of integrated auxiliary of a church; (b) Any organization which is not a private foundation (as defined in sec-tion 509(a)) and the gross receipts of which in each taxable year are nor-mally not more than $5,000 (as de-scribed in subdivision (ii) of this sub-paragraph); (c) Subordinate organizations (other than private foundations) covered by a group exemption letter; (d) Solely for purposes of sections 507, 508(d)(1), 508(d)(2)(A) and 508(d)(3), 508(e), 509 and chapter 42, a trust de-scribed in section 4947(a)(1). (However, a trust described in section 501(c)(3) which was organized after October 9, 1969, shall be exempt under section 501(a) by reason of being described in section 501(c)(3) only if it files such no-tice); and (e) Any other class of organization that the Commissioner from time to time excludes from the requirement of filing notice under section 508(a). (ii) For purposes of subdivision (i) (b) of this subparagraph and paragraph (b)(7)(ii) of this section, the gross re-ceipts (as defined in subdivision (iii) of this subparagraph) of an organization are normally not more than $5,000 if: (a) During the first taxable year of the organization the organization has received gross receipts of $7,500 or less; (b) During its first 2 taxable years the aggregate gross receipts received by the organization are $12,000 or less; and (c) In the case of an organization which has been in existence for at least 3 taxable years, the aggregate gross re-ceipts received by the organization during the immediately preceding 2 taxable years, plus the current year are $15,000 or less If an organization fails to meet the re-quirements of (a), (b), or (c) of this sub-division, then with respect to the orga-nization, such organization shall be re-quired to file the notices described in section 508 (a) and (b) within 90 days after the end of the period described in (a), (b), or (c) of this subdivision or be-fore March 22, 1973, whichever is later, in lieu of the period prescribed in sub-paragraph (2)(i) of this paragraph. Thus, for example, if an organization meets the $7,500 requirement of (a) of this subdivision for its first taxable year, but fails to meet the $12,000 re-quirement of (b) of this subdivision for the period ending with its second tax-able year, then such organization shall meet the notification requirements of section 508(a)(1) and 508(b) and subpara-graph (2)(i) of this paragraph if it files such notification within 90 days after the close of its second taxable year. If an organization which has been in ex-istence at least 3 taxable years meets the requirements of (a), (b), and (c) with respect to all prior taxable years, but fails to meet the requirements of (c) of this subdivision with respect to the current taxable year, then even if the organization fails to make such no-tification within 90 days after the close of the current taxable year, section 508(a)(1) and 508(b) shall not apply with respect to its prior years. In such a case, the organization shall not be treated as described in section 501(c)(3) for a period beginning with such cur-rent taxable year and ending when such notice is given under section 508(a)(2). (iii) For a definition of gross receipts for purposes of subdivision (i)(b) of this subparagraph and paragraph (b)(7)(ii) of this section, see 1.60332(g)(4). VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00105 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15096 26 CFR Ch. I (4113 Edition) 1.5081 (4) Voluntary filings by new organiza-tions excepted from filing notice. Any or-ganization excepted from the require-ment of filing notice under section 508(a) will be exempt from taxation under section 501(c)(3) if it meets the requirements of that section, whether or not it files such notice. However, in order to establish its exemption with the Internal Revenue Service and re-ceive a ruling or determination letter recognizing its exempt status, an orga-nization excepted from the notice re-quirement by reason of subparagraph (3) of this paragraph should file proof of its exemption in the manner prescribed in 1.501(a)1. (b) Presumption that old and new orga-nizations are private foundations(1) In general. Except as provided in subpara-graph (7) of this paragraph, any organi-zation (including an organization in ex-istence on October 9, 1969) which is de-scribed in section 501(c)(3), and which does not notify the Commissioner with-in the time and in the manner pre-scribed in subparagraph (2) that it is not a private foundation, will be pre-sumed to be a private foundation. (2) Filing of notice. (i) Except as pro-vided in subparagraph (7) of this para-graph, an organization must file the notice described in section 508(b) and subparagraph (1) of this paragraph within 15 months from the end of the month in which such organization was organized, or before March 22, 1973, whichever comes later. See paragraph (a)(2)(iii) of this section, for rules per-taining to when an organization is or-ganized. (ii) Any organization filing notice under this paragraph that has received a ruling or determination letter from the Internal Revenue Service dated on or before July 13, 1970, recognizing its exemption from taxation under section 501(c)(3) (or the corresponding provi-sions of prior law), shall file the notice described in section 508(b) by submit-ting a properly completed and executed Form 4653, Notification Concerning Foundation Status. (iii) The financial schedule on Form 4653 need be completed only if the orga-nization is, or thinks it might be, de-scribed in section 170(b)(1)(A) (iv) or (vi) or section 509(a)(2). (iv) Any organization filing notice under this paragraph that has not re-ceived a ruling or determination letter from the Internal Revenue Service dated on or before July 13, 1970, recog-nizing its exemption from taxation under section 501(c)(3) (or the cor-responding provisions of prior law), shall file its notice by submitting a properly completed and executed Form 1023 and providing information that it is not a private foundation. The organi-zation shall also submit all informa-tion required by the regulations under section 170 or 509 (whichever is applica-ble) necessary to establish recognition of its classification as an organization described in section 509(a) (1), (2), (3), or (4). A Form 1023 submitted prior to July 14, 1970, will satisfy this require-ment if the organization submits an additional statement that it is not a private foundation together with all pertinent additional information re-quired. Any statement filed under this subdivision shall be accompanied by a written declaration by the principal of-ficer, manager or authorized trustee that there is a reasonable basis in law and in fact for the statement that the organization so filing is not a private foundation, and that to the best of the knowledge and belief of such officer, manager or trustee, the information submitted is complete and correct. (v) The notice filed under subdivision (ii) of this subparagraph should be filed in accordance with the instructions ap-plicable to Form 4653. The notice re-quired by subdivision (iv) of this sub-paragraph should be filed with the dis-trict director. An extension of time for the filing of such notice may be grant-ed by the Director of the Internal Rev-enue Service Center or district director upon timely request by the organiza-tion to such person, if the organization demonstrates that additional time is required. (3) Effect of notice upon the filing orga-nization. (i) The notice filed under this paragraph may not be relied upon by the organization so filing unless and until the Internal Revenue Service no-tifies the organization that it is an or-ganization described in paragraph (1), (2), (3), or (4), of section 509(a). For pur-poses of the preceding sentence, an or-ganization that has filed notice under VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00106 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15097 Internal Revenue Service, Treasury 1.5081 section 508(b), and has previously re-ceived a ruling that it is an organiza-tion described in section 170(b)(1)(A) (other than clauses (vii) and (viii) thereof), will be considered to have been notified by the Internal Revenue Service that it is an organization de-scribed in paragraph (1) of section 509(a) if (a) the facts and circumstances forming the basis for the issuance of such ruling have not substantially changed, and (b) the ruling issued under that section has not been re-voked expressly or by a subsequent change of the law or regulations under which the ruling was issued. (ii) If an organization has filed a no-tice under section 508(b) stating that it is not a private foundation and desig-nating only one paragraph of section 509(a) under which it claims recogni-tion of its classification (such as an or-ganization described in section 509(a)(2)), and if it has received a ruling or determination letter which recog-nizes that it is not a private foundation but which fails to designate the para-graph under section 509(a) in which it is described, then such organization will be treated as described under the paragraph designated by it, until such ruling or determination letter is modi-fied or revoked. The rule in the pre-ceding sentence shall not apply to an organization which indicated that it does not know its status under section 509(a) or which claimed recognition of its status under more than one para-graph of section 509(a). (4) Effect of notice upon grantors or contributors to the filing organization. In the case of grants, contributions, or distributions made prior to: (i) In the case of community trusts, 6 months after the date on which correc-tive and clarifying regulations des-ignated as 1.170A9(e)(10) become final; (ii) In the case of medical research organizations, 6 months after the date on which corrective and clarifying reg-ulations designated as 1.170A9(b)(2), become final, and (iii) In all other cases, January 1, 1976, any organization which has prop-erly filed the notice described in sec-tion 508(b) prior to March 22, 1973 will not be treated as a private foundation for purposes of making any determina-tion under the internal revenue laws with respect to a grantor, contributor or distributor (as for example, a pri-vate foundation distributing all of its net assets pursuant to a section 507(b)(1)(A) termination) thereto, un-less the organization is controlled di-rectly or indirectly by such grantor, contributor or distributor, if by the 30th day after the day on which such notice is filed, the organization has not been notified by the Commissioner that the notice filed by such organization has failed to establish that such orga-nization is not a private foundation. See subparagraph (6) of this paragraph for the effect of an adverse notice by the Internal Revenue Service. For pur-poses of this subparagraph, an organi-zation which has properly filed notice described in section 508(b) prior to March 22, 1973, and which has claimed recognition of its status under only one paragraph of section 509(a) in such no-tice, will be treated only for purposes of grantors, contributors or distribu-tors as having the classification claimed in the notice if the provisions of this subparagraph are otherwise sat-isfied. (5) Statement that old and new organi-zations are operating foundations. (i) Any organization (including an organi-zation in existence on October 9, 1969) which is described in section 501(c)(3) may submit a statement, in the form and manner provided for notice in sub-paragraph (2) of this paragraph, that it is an operating foundation (as defined in section 4942(j)(3)) and include in such statement: (a) Necessary supporting information as required by the regulations under section 4942(j)(3) to confirm such deter-mination (including a statement iden-tifying the clause of section 4942(j)(3)(B) that is applicable); and (b) A written declaration by the prin-cipal officer, manager, or authorized trustee that there is a reasonable basis in law and in fact that the organization so filing is an operating foundation, and that to the best of the knowledge and belief of such officer, manager or trustee, the information submitted is complete and correct. (ii) The statement filed under this subparagraph may not be relied upon by the organization so filing unless and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00107 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15098 26 CFR Ch. I (4113 Edition) 1.5082 until the Internal Revenue Service no-tifies the organization that it is an op-erating foundation described in section 4942(j)(3). (iii) In the case of grants, contribu-tions, or distributions made prior to March 22, 1973, any organization which has properly filed the statement de-scribed in this subparagraph prior to such date will be treated as an oper-ating foundation for purposes of mak-ing any determination under the inter-nal revenue laws with respect to a grantor, contributor, or distributor thereto, unless the organization is con-trolled directly or indirectly by such grantor, contributor, or distributor, if by the 30th day after the day on which such statement is filed, the organiza-tion has not been notified by the Com-missioner or his delegate that its state-ment has failed to establish that such organization is an operating founda-tion. See subparagraph (6) of this para-graph for the effect of an adverse no-tice by the Internal Revenue Service. (6) Effect of notice by Internal Revenue Service concerning organizations notice or statement. Subparagraph (4) and sub-division (iii) of subparagrph (5) of this paragraph shall have no effect: (i) With respect to a grantor, contrib-utor, or distributor to any organization for any period after the date on which the Internal Revenue Service makes notice to the public (such as by publi-cation in the Internal Revenue Bul-letin) that a grantor, contributor, or distributor to such organization can no longer rely upon the notice or state-ment submitted by such organization; and (ii) Upon any grant, contribution, or distribution made to an organization on or after the date on which a grantor, contributor, or distributor acquired knowledge that the Internal Revenue Service has given notice to such orga-nization that its notice or statement has failed to establish that such orga-nization either is not a private founda-tion, or is an operating foundation, as the case may be. (7) Exceptions from notice. Subpara-graphs (1) and (2) of this paragraph are inapplicable to the following organiza-tions: (i) Churches, interchurch organiza-tions of local units of a church, conven-tions or associations of churches, or in-tegrated auxiliaries of a church, such as a mens or womens organization, re-ligious school, mission society, or youth group; (ii) Any organization which is not a private foundation (as defined in sec-tion 509(a)) and the gross receipts of which in each taxable year are nor-mally not more than $5,000 (as deter-mined under paragraph (a)(3)(ii) of this section); (iii) Subordinate organizations (other than private foundations) covered by a group exemption letter but only if the parent or supervisory organization sub-mits a notice covering the subordi-nates; (iv) Trusts described in section 4947(a)(1); and (v) Any other class of organization that the Commissioner from time to time excludes from the notification re-quirements of section 508(b). (8) Voluntary filings by organizations excepted from filing notice. Any organi-zation excepted from the requirement of filing notice under section 508(b) by reason of subdivisions (i), (ii), and (v) of subparagraph (7) of this paragraph may receive the benefits of subpara-graph (4) of this paragraph by filing such notice. (Secs. 508 and 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 26 U.S.C. 7805)) [T.D. 7232, 37 FR 28289, Dec. 22, 1972, as amended by T.D. 7342, 40 FR 1237, Jan. 7, 1975; T.D. 7395, 41 FR 1063, Jan. 6, 1976; T.D. 8640, 60 FR 65552, Dec. 20, 1995] 1.5082 Disallowance of certain char-itable, etc., deductions. (a) Gift or bequest to organizations sub-ject to section 507(c) tax(1) General rule. No gift or bequest made to an organiza-tion upon which the tax provided by section 507(c) has been imposed shall be allowed as a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, if such gift or be-quest is made: (i) By any person after notification has been made by the organization under section 507(a)(1) or after notifica-tion has been made by the Commis-sioner under section 507(a)(2)(B), or (ii) By a substantial contributor (as defined in section 507(d)(2)) in his tax-able year which includes the first day VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00108 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC15099 Internal Revenue Service, Treasury 1.5082 on which action is taken by such orga-nization which culminates in the impo-sition of tax under section 507(c) and any subsequent taxable year For purposes of subdivision (ii) of this subparagraph, the first day on which action is taken by an organization which culminates in the imposition of tax under section 507(c) shall be deter-mined under the rules set forth in 1.5077(b) (1) and (2). (2) Exception. Subparagraph (1) of this paragraph shall not apply if the entire amount of the unpaid portion of the tax imposed by section 507(c) is abated by the Commissioner under section 507(g). (b) Gift or bequest to taxable private foundation, section 4947 trust, etc.(1) General rule. (i) Except as provided in subparagraph (2) of this paragraph, no gift or bequest made to an organization shall be allowed as a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, if such gift or bequest is made: (a) To a private foundation or a trust described in section 4947(a)(2) in a tax-able year for which it fails to meet the requirements of section 508(e) (deter-mined without regard to section 508(e)(2) (B) and (C), or (b) To any organization in a period for which it is not treated as an organi-zation described in section 501(c)(3) by reason of section 508(a). (ii) For purposes of subdivision (i)(a) of this subparagraph the term taxable year refers to the taxable year of the donee or beneficiary organization. In the event a bequest is made to a pri-vate foundation or trust described in section 4947(a)(2) which is not in exist-ence at the date of the testators death (but which is created under the terms of the testators will), the term taxable year shall mean the first taxable year of the private foundation or trust. (iii) For purposes of subdivision (i)(a) of this subparagraph, an organization does not fail to meet the requirements of section 508(e) for a taxable year, un-less it fails to meet such requirements for the entire year. Therefore, even if a donee organization fails to meet the re-quirements of section 508(e) on the date it receives a grant from a donor, the donors grant will not be disallowed by operation of section 508(d)(2)(A) and subdivision (i)(a) of this subparagraph, if the organization meets the require-ments of section 508(e) (determined without regard to section 508(e)(2) (B) or (C) ) by the end of its taxable year. (iv) No deduction will be disallowed under section 508(d)(2)(A) with respect to a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 if during the taxable year in question, the private foundation or trust described in section 4947(a)(2) has instituted a judicial proceeding which is necessary to reform its governing in-strument or other instrument in order to meet the requirements of section 508(e)(1). This subdivision shall not apply unless within a reasonable time such judicial proceedings succeed in so reforming such instrument. (v) No deduction will be disallowed under section 508(d)(2)(A) and subdivi-sion (i)(a) of this subparagraph for any taxable year beginning before January 1, 1972, with respect to a private foun-dation or trust described in section 4947 organized before January 1, 1970. See also 1.5083(g) regarding transitional rules for extending compliance with section 508(e)(1). (vi)(a) In the case of a contribution or bequest to a trust described in sec-tion 4947(a)(2) other than to a trust to which subdivision (vii) of this subpara-graph applies, no deduction shall be disallowed by reason of section 508(d)(2)(A) on the grounds that such trusts governing instrument contains no provisions with respect to section 4942. Similarly, if for a taxable year such trust is also a trust described in section 4947(b)(3), no deduction for such year shall be so disallowed on the grounds that the governing instrument contains no provision with respect to section 4943 or 4944. (b) This subdivision may be illus-trated by the following example: Example. H executes a will on January 1, 1977, establishing a charitable remainder trust (as described in section 664) with in-come payable to W, his wife, for life, remain-der to X university, an organization de-scribed in section 170(b)(1)(A)(ii). The will provides that the trust is prohibited from en-gaging in activities which would subject itself, its foundation manager or a disquali-fied person to taxes under section 4941 or 4945 of the Code. The will is silent as to sections 4942, 4943, and 4944. H dies February 12, 1978. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00109 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150100 26 CFR Ch. I (4113 Edition) 1.5082 Section 508(d)(2)(A) will not operate to dis-allow any deduction to Hs estate under sec-tion 2055 with respect to such trust. (vii)(a) In the case of a trust de-scribed in section 4947(a)(2) which by its terms will become a trust described in section 4947(a)(1) and the governing instrument of which is executed after March 22, 1973, the governing instru-ment shall not meet the requirements of section 508(e)(1) if it does not con-tain provisions to the effect that the trust must comply with the provisions of section 4942, or sections 4942, 4943, and 4944 (as the case may be) to the ex-tent such section or sections shall be-come applicable to such trust. (b) This subdivision may be illus-trated by the following example: Example. H executes a will on January 1, 1977, establishing a charitable remainder trust (as described in section 664) with in-come payable to W, his wife, for life, remain-der in trust in perpetuity for the benefit of an organization described in section 170(c). By its terms the trust will become a trust described in section 4947(a)(1), and will be-come a private foundation. The will provides that the trust is prohibited from engaging in activities which would subject itself, its foundation manager or a disqualified person to taxes under sections 4941 or 4945 of the Code. The will is silent as to sections 4942, 4943, and 4944. H dies February 12, 1978. Un-less the trusts governing instrument is amended prior to the end of the trusts first taxable year, or judicial proceedings have been instituted under subdivision (iv) of this subparagraph, section 508(d)(2)(A) will oper-ate to disallow any deduction to Hs estate under section 2055 with respect to such trust. (viii) Since a charitable trust de-scribed in section 4947(a)(1) is not re-quired to file a notice under section 508(a), section 508(d)(2)(B) and subdivi-sion (i)(b) of this subparagraph are not applicable to such a trust. (2) Transitional rules. Any deduction which would otherwise be allowable under section 642(c)(2), 2106(a)(2), or 2055 shall not be disallowed under sec-tion 508(d)(2)(A) if such deduction is at-tributable to: (i) Property passing under the terms of a will executed on or before October 9, 1969, (a) If the decedent dies after October 9, 1969, but before October 9, 1972, with-out having amended any dispositive provision of the will after October 9, 1969, by codicil or otherwise, (b) If the decedent dies after October 9, 1969, and at no time after that date had the right to change the portions of the will which pertains to the passing of property to, or for the use of, an or-ganization described in section 170(c)(2)(B) or 2055(a), or (c) If no dispositive provision of the will is amended by the decedent, by codicil or otherwise, before October 9, 1972, and the decedent is on October 9, 1972, and at all times thereafter under a mental disability (as defined in 1.642(c)2(b)(3)(ii)) to amend the will by codicil or otherwise, or (ii) Property transferred in trust on or before October 9, 1969, (a) If the grantor dies after October 9, 1969, but before October 9, 1972, without having amended, after October 9, 1969, any dispositive provision of the instru-ment governing the disposition of the property, (b) If the property transferred was an irrevocable interest to, or for the use of, an organization described in section 170(c)(2)(B) or 2055(a), (c) In the case of a deduction under section 2106(a)(2) or 2055; if no disposi-tive provision of the instrument gov-erning the disposition of the property is amended by the grantor before Octo-ber 9, 1972, and the grantor is on Octo-ber 9, 1972, and at all times thereafter under a mental disability (as defined in 1.642(c)2(b)(3)(ii)) to change the dis-position of the property, or (d) In the case of a deduction under section 642(c)(2)(A), if the grantor is at all times after October 9, 1969, and up to, and including, the last day of the taxable year for which the deduction under such section is claimed, under a mental disability (as defined in 1.642(c)2(b)(3)(ii)) to change the terms of the trust See also 1.5083(g) regarding the ex-tension of time for compliance with section 508(e), 1.6641(f)(3) (ii) and (g) regarding the special transitional rules for charitable remainder annuity and unitrusts described in section 664 which were created prior to December 31, 1972, and 20.20552(e)(4) of this chapter re-garding the rules for determining if the dispositive provisions have been amended. [T.D. 7232, 37 FR 28291, Dec. 22, 1972] VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00110 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150101 Internal Revenue Service, Treasury 1.5083 1.5083 Governing instruments. (a) General rule. A private foundation shall not be exempt from taxation under section 501(a) for a taxable year unless by the end of such taxable year its governing instrument includes pro-visions the effects of which are: (1) To require distributions at such times and in such manner as not to subject the foundation to tax under section 4942, and (2) To prohibit the foundation from engaging in any act of self-dealing (as defined in section 4941(d)), from retain-ing any excess business holdings (as de-fined in section 4943(c)), from making any investments in such manner as to subject the foundation to tax under section 4944, and from making any tax-able expenditures (as defined in section 4945(d)). (b) Effect and nature of governing in-strument(1) In general. Except as pro-vided in paragraph (d) of this section, the provisions of a foundations gov-erning instrument must require or pro-hibit, as the case may be, the founda-tion to act or refrain from acting so that the foundation, and any founda-tion managers or other disqualified persons with respect thereto, shall not be liable for any of the taxes imposed by sections 4941, 4942, 4943, 4944, and 4945 of the Code or, in the case of a split-interest trust described in section 4947(a)(2), any of the taxes imposed by those sections of chapter 42 made appli-cable under section 4947. Specific ref-erence to these sections of the Code will generally be required to be in-cluded in the governing instrument, unless equivalent language is used which is deemed by the Commissioner to have the same full force and effect. However, a governing instrument which contains only language suffi-cient to satisfy the requirements of the organizational test under 1.501(c)(3) 1(b) will not be considered as meeting the requirements of this subparagraph, regardless of the interpretation placed on such language as a matter of law by a State court in a particular jurisdic-tion, unless the requirements of para-graph (d) of this section are satisfied. (2) Corpus. A governing instrument does not meet the requirements of paragraph (a)(1) of this section if it ex-pressly prohibits the distribution of capital or corpus. (3) Savings provisions. For purposes of sections 508(d)(2) (A) and (e), a gov-erning instrument need not include any provision which is inconsistent with section 101(l) (2), (3), (4), or (5) of the Tax Reform Act of 1969 (83 Stat. 533), as amended by sections 1301 and 1309 of the Tax Reform Act of 1976 (90 Stat. 1713, 1729), with respect to the or-ganization. Accordingly, a governing instrument complying with the re-quirements of subparagraph (1) of this paragraph may incorporate any savings provision contained in section 101(l) (2), (3), (4), or (5) of the Tax Reform Act of 1969, as amended by sections 1301 and 1309 of the Tax Reform Act of 1976, as a specific exception to the general provi-sions of paragraph (a) of this section. In addition, in the absence of any ex-press provisions to the contrary, the exceptions contained in such savings provisions will generally be regarded as contained in a governing instrument meeting the requirements of subpara-graph (1) of this paragraph. (4) Excess holdings. For purposes of paragraph (a)(2) of this section, the prohibition against retaining any excess business holdings (as defined in section 4943(c)) shall be deemed only to pro-hibit the foundation from retaining any excess business holdings when such holdings would subject the foundation to tax under section 4943(a). (5) Revoked ruling on status. In the case of an organization which: (i) Has been classified as an organiza-tion described in section 509(a) (1), (2), (3), or (4), and (ii) Subsequently receives a ruling or determination letter stating that it is no longer described in section 509(a) (1), (2), (3), or (4), but is a private founda-tion within the meaning of section 509, such organization shall have 1 year from the date of receipt of such ruling or determination letter, or the final ruling or determination letter if a pro-test is filed to an earlier one, to meet the requirements of section 508(e). Sec-tion 508(d)(2)(A) shall not be applicable with respect to gifts and bequests made during this 1-year period if such re-quirements are met within the 1-year period. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00111 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150102 26 CFR Ch. I (4113 Edition) 1.5083 (6) Judicial proceeding. For purposes of paragraphs (a), (b)(5), (d)(2), and (e)(3) of this section, an organization shall be deemed to have met the requirements of section 508(e) within a year, if a judi-cial proceeding which is necessary to reform its governing instrument or other instrument is instituted within the year and within a reasonable time the organization, in fact, meets the re-quirements of section 508(e). For pur-poses only of paragraphs (b)(5), (d)(2), and (e)(3) of this section, if an organi-zation organized before January 1, 1970, institutes such a judicial proceeding within such 1-year period, section 508 (e)(2)(C) shall be applied as if such pro-ceeding had been instituted prior to January 1, 1972. (c) Meaning of governing instrument. For purposes of section 508(e), the term governing instrument shall have the same meaning as the term articles of or-ganization under 1.501(c)(3)1(b)(2). The bylaws of an organization shall not constitute its governing instrument for purposes of section 508(e). (d) Effect of State law(1) In general. A private foundations governing in-strument shall be deemed to conform with the requirements of paragraph (a) of this section if valid provisions of State law have been enacted which: (i) Require it to act or refrain from acting so as not to subject the founda-tion to the taxes imposed by section 4941 (relating to taxes on self-dealing), 4942 (relating to taxes on failure to dis-tribute income), 4943 (relating to taxes on excess business holdings), 4944 (re-lating to taxes on investments which jeopardize charitable purpose), and 4945 (relating to taxable expenditures); or (ii) Treat the required provisions as contained in the foundations gov-erning instrument. (2) Validity. (i) Any provision of State law described in subparagraph (1) of this paragraph shall be presumed valid as enacted, and in the absence of State provisions to the contrary, to apply with respect to any foundation that does not specifically disclaim coverage under State law (either by notification to the appropriate State official or by commencement of judicial proceedings) except as provided in subdivisions (ii) and (iii) of this subparagraph. (ii) If such provision is declared in-valid or inapplicable with respect to a class of foundations by the highest ap-pellate court of the State or by the Su-preme Court of the United States, the foundations covered by the determina-tion must meet the requirements of section 508(e) within 1 year from the date on which the time for perfecting an application for review by the Su-preme Court expires. If such applica-tion is filed, the requirements of sec-tion 508(e) must be met within a year from the date on which the Supreme Court disposes of the case, whether by denial of the application for review or decision on the merits. (iii) In addition, if such provision of State law is declared invalid or inappli-cable with respect to a class of founda-tions by any court of competent juris-diction which decision is not reviewed by a court referred to in subdivision (ii) of this subparagraph, and the Commis-sioner makes notice to the general pub-lic (such as by publication in the Inter-nal Revenue Bulletin) that such provi-sion has been so declared invalid or in-applicable, then all foundations in such State must meet the requirements of section 508(e), without reliance upon such statute to the extent declared in-valid or inapplicable by such decision, within 1 year from the date such notice is made public. (iv) This subparagraph shall not apply to any foundation that is subject to a final judgment entered by a court of competent jurisdiction, holding the law invalid or inapplicable with respect to such foundation. See paragraph (b)(6) of this section for the effect of certain judicial proceedings that are brought within 1 year. (3) Conflicting instrument. For taxable years beginning after March 22, 1973 in order for a private foundation or trust described in section 4947(a)(2) to re-ceive the benefit of coverage under any State statute which makes applicable the requirements of section 508(e)(1) (A) and (B), where the statute by its terms does not apply to a governing in-strument which contains a mandatory direction conflicting with any of such requirements, such organization must indicate on its annual return required VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00112 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150103 Internal Revenue Service, Treasury 1.5083 to be filed under section 6033 (or sec-tion 6012 in the case of a trust de-scribed in section 4947(a)) that its gov-erning instrument contains no manda-tory directions which conflict with the requirements of section 508(e)(1) (A) or (B), as incorporated by the State stat-ute. General language in a governing instrument empowering the trustee to make investments without being lim-ited to those investments authorized by law will not be regarded as a manda-tory conflicting direction. (4) Exclusion from statute. (i) For any taxable year beginning after March 22, 1973 in the case of a private foundation or trust described in section 4947(a)(2) subject to a State statute which makes applicable the requirements of section 508(e)(1) (A) and (B) to the governing instruments of such organizations, other than those which take action to be excluded therefrom (such as by fil-ing a notice of exclusion or by insti-tuting appropriate judicial pro-ceedings), an organization will receive the benefit of such State statute only if it indicates on its annual return re-quired to be filed under section 6033 (or section 6012 in the case of a trust de-scribed in section 4947(a)) that it has not so taken action to be excluded. (ii) This paragraph permits certain organizations that are subject to the provisions of such a State law, to avoid changing their governing instruments in order to meet the requirements of section 508(e)(1). Since an organization which avoids the application of a provi-sion or provisions of State law, such as by filing a notice of exclusion, is not entitled to the benefits of this para-graph, such an organization must meet the requirements of section 508(e)(1) without regard to this paragraph and except as provided in section 508(e)(2)(C) or paragraph (g)(1)(iii) of this section must change its governing instrument to the extent inconsistent with section 508(e)(1). (5) Treatment of prevailing conflicting clause. If provisions of State law are in-applicable to a clause in a governing instrument which is contrary to the provisions of section 508(e)(1), the re-quirements of section 508(e)(2)(C) and paragraph (g)(1)(iii) of this section are not satisfied by a provision of State law which purports to eliminate the need for litigation under such cir-cumstances. Therefore, except as oth-erwise provided in this section unless the governing instrument is changed or litigation is commenced pursuant to section 508(e)(2)(B) by an organization organized before January 1, 1970, or pursuant to paragraph (g)(1)(ii) of this section, to amend the nonconforming provision to meet the requirements of section 508(e)(1) (A) and (B), then pur-suant to section 508(e), such organiza-tion will not be exempt from taxation. (6) Retroactive application to grants or bequests. If valid provisions of such a State law apply retroactively to a tax-able year within which an organization has received a grant or request, section 508(d)(2)(A) shall not apply so as to dis-allow such grant or bequest, but only if such valid provisions of State law are enacted within 2 years of such grant or bequest. (e) Effect of section 508(e) upon section 4947 trusts(1) Section 4947(a)(1) trusts. A charitable trust described in section 4947(a)(1) (unless also described in a paragraph of section 509(a)) is subject to all the provisions of paragraph (a) of this section. (2) Section 4947(a)(2) trusts. A split-in-terest trust described in section 4947(a)(2), as long as it is so described, is subject to the provisions of para-graph (a)(2) of this section, except to the extent that section 4947 makes any such provisions inapplicable to certain trusts and certain amounts in trust. The governing instrument of a trust described in section 4947(a)(2) may ex-cept amounts described in section 4947(a)(2) (A), (B), and (C) from the re-quirements of paragraph (a)(2) of this section. In the case of a trust having amounts transferred to it both before May 27, 1969, and after May 26, 1969, its governing instrument may except from the provisions of paragraph (a)(2) of this section only those segregated amounts excluded from the application of section 4947(a)(2) by reason of sec-tion 4947(a)(2)(C) and the regulations thereunder. Also, the governing instru-ment of such a trust may exclude the application of sections 4943 and 4944 for any period during which such trust is described in section 4947(b)(3) (A) or (B). See 53.49471(c) of this chapter for rules relating to the applicability of VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00113 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150104 26 CFR Ch. I (4113 Edition) 1.5083 section 4947 to split-interest trusts and 1.5082(b)(1) (vi) and (vii) for rules re-lating to the deductibility of grants or bequests to such trusts. (3) A section 4947(a)(2) trust becoming a section 4947(a)(1) trust. If the governing instrument of a trust described in sec-tion 4947(a)(2) meets the applicable re-quirements of paragraph (a)(2) of this section and such trust ceases to be so described and becomes instead a trust described in section 4947(a)(1), then such governing instrument must meet, prior to the end of 12 months from the date such trust first becomes described in section 4947(a)(1) (except as other-wise provided in this section) all the requirements of paragraph (a) of this section in order to comply with section 508(e). (f) Special rules for existing private foundations. (1) Pursuant to section 508(e)(2), section 508(e)(1) and paragraph (a) of this section shall not apply in the case of any organization whose gov-erning instrument was executed before January 1, 1970: (i) To any taxable year beginning be-fore January 1, 1972; (ii) To any period after December 31, 1971, during the pendency of any judi-cial proceeding begun before January 1, 1972, by the private foundation which is necessary to reform, or to excuse such foundation from compliance with, its governing instrument or any other in-strument in order to meet the require-ments of section 508(e)(1); and (iii) To any period after the termi-nation of any judicial proceeding de-scribed in subdivision (ii) of this sub-paragraph during which its governing instrument or any other instrument does not permit it to meet the require-ments of section 508(e)(1). (2) For purposes of subparagraph (1) of this paragraph, and 1.508 2(b)(1)(vi)(a), a governing instrument will not be treated as executed before the applicable date, if, after such date the dispositive provisions of the instru-ment are amended (determined under rules similar to the rules set forth in 20.20552(e)(4) of this chapter). (3) For purposes of subparagraph (1) (ii) and (iii) of this paragraph, a private foundation will be treated as meeting the requirements of section 508(e)(2) (B) and (C) if it has commenced a nec-essary and timely proceeding in an ap-propriate court of original jurisdiction and such court has ruled that the foun-dations governing instrument or any other instrument does not permit it to meet the requirements of section 508(e)(1). Such foundation is not re-quired to commence proceedings in any court of appellate jurisdiction in order to comply with section 508(e)(2)(C). See also 1.5082(b)(2). (g) Extension of time for compliance with section 508(e). (1) Except as pro-vided in subparagraph (2) of this para-graph, section 508(e)(1) shall not apply to any private foundation (regardless of when organized) with respect: (i) To any taxable year beginning be-fore the transitional date, (ii) To any period on or after the transitional date during the pendency of any judicial proceeding begun before the transitional date by the private foundation which is necessary to re-form, or to excuse such foundation from compliance with, its governing instrument or any other instrument in order to meet the requirements of sec-tion 508(e)(1), and (iii) To any period after the termi-nation of any judicial proceeding de-scribed in subdivision (ii) of this sub-paragraph during which its governing instrument or any other instrument does not permit it to meet the require-ments of section 508(e)(1). (2) Subparagraph (1) of this para-graph shall apply only to gifts or be-quests referred to in section 508(d)(2)(A) that are made before the transitional date. (3) For purposes of this paragraph the term transitional dates means the ear-lier of the following dates: (i) In the case of a medical research organization, May 21, 1976 or in the case of a community trust February 10, 1977, or (ii) The 91st day after the date an or-ganization receives a final ruling or de-termination letter that it is a private foundation under section 509(a). [T.D. 7232, 37 FR 28292, Dec. 22, 1972, as amended by T.D. 7440, 41 FR 50656, Nov. 17, 1976; T.D. 7678, 45 FR 12415, Feb. 26, 1980] VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00114 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150105 Internal Revenue Service, Treasury 1.509(a)3 1.5084 Effective date. Except as otherwise provided, 1.508 1 through 1.5083 shall take effect on January 1, 1970. (Sec. 7805 of the Internal Revenue Code of 1954, 68A Stat. 917; 26 U.S.C. 7805) [T.D. 7232, 37 FR 28294, Dec. 22, 1972] 1.509(a)1 Definition of private foun-dation. In general. Section 509(a) defines the term private foundation to mean any domestic or foreign organization de-scribed in section 501(c)(3) other than an organization described in section 509(a) (1), (2), (3), or (4). Organizations which fall into the categories excluded from the definition of private founda-tion are generally those which either have broad public support or actively function in a supporting relationship to such organizations. Organizations which test for public safety are also ex-cluded. [T.D. 7212, 37 FR 21907, Oct. 17, 1972] 1.509(a)2 Exclusion for certain orga-nizations described in section 170(b)(1)(A). (a) General rule. Organizations de-scribed in section 170(b)(1)(A) (other than in clauses (vii) and (viii)) are ex-cluded from the definition of private foundation by section 509(a)(1). For the requirements to be met by organiza-tions described in section 170(b)(1)(A) (i) through (vi), see 1.170A9 (a) through (e) and paragraph (b) of this section. For purposes of this section, the parenthetical language other than in clauses (vii) and (viii) used in section 509(a)(1) means other than an organiza-tion which is described only in clause (vii) or (viii). For purposes of this section, an organization may qualify as a section 509(a)(1) organization regardless of the fact that it does not satisfy section 170(c)(2) because: (1) Its funds are not used within the United States or its possessions, or (2) It was created or organized other than in, or under the law of, the United States, any State or territory, the Dis-trict of Columbia, or any possession of the United States. (b) Medical research organizations. In order to qualify under section 509(a)(1) as a medical research organization de-scribed in section 170(b)(1)(A)(iii), an organization must meet the require-ments of section 170(b)(1)(A)(iii) and 1.170A9(c)(2), except that, solely for purposes of classification as a section 509(a)(1) organization, such organiza-tion need not be committed to spend every contribution for medical re-search before January 1 of the fifth cal-endar year which begins after the date such contribution is made. [T.D. 7212, 37 FR 21907, Oct. 17, 1972] 1.509(a)3 Broadly, publicly sup-ported organizations. (a) In general(1) General rule. Sec-tion 509(a)(2) excludes certain types of broadly, publicly supported organiza-tions from private foundation status. An organization will be excluded under section 509(a)(2) if it meets the one- third support test under section 509(a)(2)(A) and the not-more-than-one- third support test under section 509(a)(2)(B). (2) One-third support test. An organi-zation will meet the one-third support test if it normally (within the meaning of paragraph (c) or paragraph (d) of this section) receives from permitted sources more than one-third of its sup-port in each taxable year from any combination of (i) Gifts, grants, contributions, or membership fees; and (ii) Gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in an activity that is not an unrelated trade or business (within the meaning of section 513), subject to certain limi-tations described in paragraph (b) of this section. For purposes of this sec-tion, governmental units, organiza-tions described in section 509(a)(1), and persons other than disqualified persons with respect to the organization shall be referred to as permitted sources. For purposes of this section, the amount of support received from the sources de-scribed in paragraph (a)(2)(i) of this section and this paragraph (a)(2)(ii) (subject to the limitations referred to in this paragraph (a)(2)) will be referred to as the numerator of the one-third support fraction, and the total amount of support received (as defined in sec-tion 509(d)) will be referred to as the denominator of the one-third support VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00115 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150106 26 CFR Ch. I (4113 Edition) 1.509(a)3 fraction. Section 1.509(a)3(f) distin-guishes gifts and contributions from gross receipts; 1.509(a)3(g) distin-guishes grants from gross receipts; 1.509(a)3(h) defines membership fees; 1.509(a)3(i) defines any bureau or similar agency of a governmental unit; 1.509(a)3(j) describes the treat-ment of certain indirect forms of sup-port; paragraph (k) of this section de-scribes the method of accounting for support; 1.509(a)3(l) describes the treatment of gross receipts from sec-tion 513(a)(1), section 513(a)(2), or sec-tion 513(a)(3) activities; 1.509(a)3(m) distinguishes gross receipts from gross investment income; and 1.509(a)3(n) describes transition rules for organiza-tions that received advance rulings that expire on or after June 9, 2008. (3) Not-more-than-one-third support test(i) In general. An organization will meet the not-more-than-one-third sup-port test under section 509(a)(2)(B) if it normally (within the meaning of para-graph (c) or (d) of this section) receives not more than one-third of its support in each taxable year from the sum of its gross investment income (as defined in section 509(e)) and the excess (if any) of the amount of its unrelated business taxable income (as defined in section 512) derived from trades or businesses that were acquired by the organization after June 30, 1975, over the amount of tax imposed on such income by section 511. For purposes of this section the amount of support received from items described in section 509(a)(2)(B) will be referred to as the numerator of the not-more-than-one-third support frac-tion, and the total amount of support (as defined in section 509(d)) will be re-ferred to as the denominator of the not-more-than-one-third support frac-tion. For purposes of section 509(a)(2), paragraph (m) of this section distin-guishes gross receipts from gross in-vestment income. For purposes of sec-tion 509(e), gross investment income in-cludes the items of investment income described in 1.512(b)1(a). (ii) Trade or business. For purposes of section 509(a)(2)(B)(ii), a trade or busi-ness acquired after June 30, 1975, by an organization shall include, in addition to other trades or businesses: (A) A trade or business acquired after such date from, or as a result of the liquidation of, an organizations sub-sidiary which is described in section 502 whether or not the subsidiary was held on June 30, 1975. (B) A new trade or business com-menced by an organization after such date. (iii) Allocation of deductions between businesses acquired before, and businesses acquired after, June 30, 1975. Deductions which are allowable under section 512 but are not directly connected to a par-ticular trade or business, such as de-ductions referred to in paragraphs (10) and (12) of section 512(b), shall be allo-cated in the proportion that the unre-lated trade or business taxable income derived from trades or businesses ac-quired after June 30, 1975, bears to the organizations total unrelated business taxable income, both amounts being determined without regard to such de-ductions. (iv) Allocation of tax. The tax imposed by section 511 shall be allocated in the same proportion as in paragraph (a)(3)(iii) of this section. (4) Purposes. The one-third support test and the not-more-than-one-third support test are designed to insure that an organization which is excluded from private foundation status under section 509(a)(2) is responsive to the general public, rather than to the private in-terests of a limited number of donors or other persons. (b) Limitation on gross receipts(1) General rule. In computing the amount of support received from gross receipts under section 509(a)(2)(A)(ii) for pur-poses of the one-third support test of section 509(a)(2)(A), gross receipts from related activities received from any person, or from any bureau or similar agency of a governmental unit, are in-cludible in any taxable year only to the extent that such receipts do not exceed the greater of $5,000 or 1 percent of the organizations support in such taxable year. (2) Examples. The application of this paragraph may be illustrated by the examples set forth below. For purposes of these examples, the term general public is defined as persons other than disqualified persons and other than persons from whom the foundation re-ceives gross receipts in excess of the VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00116 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150107 Internal Revenue Service, Treasury 1.509(a)3 greater of $5,000 or 1 percent of its sup-port in any taxable year, and the term gross receipts is limited to receipts from activities which are not unrelated trade or business (within the meaning of section 513). Example 1. For the taxable year 1970, X, an organization described in section 501(c)(3), received support of $10,000 from the following sources: Bureau M (a governmental bureau from which X received gross receipts for services rendered) $25,000 Bureau N (a governmental bureau from which X received gross receipts for services rendered) 25,000 General public (gross receipts for services ren-dered) ............................................................... 20,000 Gross investment income .................................... 15,000 Contributions from individual substantial contrib-utors (defined as disqualified persons under section 4946(a)(2)) ........................................... 15,000 Total support ......................................... 100,000 Since the $25,000 received from each bureau amounts to more than the greater of $5,000 or 1 percent of Xs support for 1970 (1% of $100,000=$1,000) under section 509(a)(2)(A)(ii), each amount is includible in the numerator of the one-third support fraction only to the extent of $5,000. Thus, for the taxable year 1970, X received support from sources which are taken into account in meeting the one- third support test of section 509(a)(2)(A) com-puted as follows: Bureau M ............................................................. $5,000 Bureau N .............................................................. 5,000 General public ...................................................... 20,000 Total ....................................................... 30,000 Therefore, in making the computations re-quired under paragraph (c), (d), or (e) of this section, only $30,000 is includible in the ag-gregate numerator and $100,000 is includible in the aggregate denominator of the support fraction. Example 2. For the taxable year 1970, Y, an organization described in section 501(c)(3), received support of $600,000 from the fol-lowing sources: Bureau O (gross receipts for services rendered) $10,000 Bureau P (gross receipts for services rendered) 10,000 General public (gross receipts for services ren-dered) ............................................................... 150,000 General public (contributions) .............................. 40,000 Gross investment income .................................... 150,000 Contributions from substantial contributors ......... 240,000 Total support ......................................... 600,000 Since the $10,000 received from each bureau amounts to more than the greater of $5,000 or 1 percent of Ys support for 1970 (1% of $600,000=$6,000), each amount is includible in the numerator of the one-third support frac-tion only to the extent of $6,000. Thus, for the taxable year 1970, Y received support from sources required to meet the one-third support test of section 509(a)(2)(A) computed as follows: Bureau O ............................................................. $6,000 Bureau P .............................................................. 6,000 General public (gross receipts) ........................... 150,000 General public (contributions) .............................. 40,000 Total ....................................................... 202,000 Therefore, in making the computations re-quired under paragraph (c), (d), or (e) of this section, $202,000 is includible in the aggre-gate numerator and $600,000 is includible in the aggregate denominator of the support fraction. (c) Normally(1) In general(i) Defini-tion. The support tests set forth in sec-tion 509(a)(2) are to be computed on the basis of the nature of the organiza-tions normal sources of support. An organization will be considered as normally receiving one third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from permitted sources (subject to the limitations de-scribed in 1.509(a)3(b)) and not more than one third of its support from items described in section 509(a)(2)(B) for a taxable year and the taxable year immediately succeeding such year, if, for such taxable year and the four tax-able years immediately preceding such taxable year, the aggregate amount of the support received during the appli-cable period from gifts, grants, con-tributions, membership fees, and gross receipts from permitted sources (sub-ject to the limitations described in 1.509(a)3(b)) is more than one third, and the aggregate amount of the sup-port received from items described in section 509(a)(2)(B) is not more than one third, of the total support of the organization for such five-year period. A publicly supported organization de-scribed under section 509(a)(2) that has failed to meet either the one-third sup-port test of paragraph (a)(2) of this sec-tion or the not-more-than-one-third support test of paragraph (a)(3) of this section for two consecutive years will be treated as a private foundation as of the first day of the second consecutive taxable year only for purposes of sec-tions 507, 4940, and 6033. Such an orga-nization must file a Form 990PF, Re-turn of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation, and will be liable for the net investment VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00117 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150108 26 CFR Ch. I (4113 Edition) 1.509(a)3 tax imposed by section 4940 and, if ap-plicable, the private foundation termi-nation tax imposed by section 507(c), for that second consecutive failed year. For the succeeding years, the organiza-tion will be treated as a private foun-dation for all purposes. (ii) First five years of an organizations existence. See paragraph (d)(1) of this section for the definition of nor-mally for organizations in the first five years of their existence. (2) Terminations under section 507(b)(1)(B). For the special rules appli-cable to the term normally as applied to private foundations that elect to terminate their private foundation sta-tus pursuant to the 60-month procedure provided in section 507(b)(1)(B), see the regulations under such section. (3) Exclusion of unusual grants. For purposes of applying the tests for sup-port set forth in paragraphs (a)(2) and (a)(3) of this section, one or more con-tributions may be excluded from the numerator of the one-third support fraction and from the denominator of both the one-third support and not- more-than-one-third support fractions only if such a contribution meets the requirements of this paragraph (c)(3). The exclusion provided by this para-graph (c)(3) is generally intended to apply to substantial contributions and bequests from disinterested parties, which contributions or bequests (i) Are attracted by reason of the publicly supported nature of the orga-nization; (ii) Are unusual or unexpected with respect to the amount thereof; and (iii) Would by reason of their size, ad-versely affect the status of the organi-zation as normally meeting the one- third support test for any of the appli-cable periods described in this para-graph (c) or paragraph (d) of this sec-tion. In the case of a grant (as defined in 1.509(a)3(g)) that meets the re-quirements of this paragraph (c)(3), if the terms of the granting instrument require that the funds be paid to the recipient organization over a period of years, the grant amounts may be ex-cluded for such year or years in which they would otherwise be includible in computing support under the method of accounting on the basis of which the organization regularly computes its in-come in keeping its books under sec-tion 446. However, no item described in section 509(a)(2)(B) may be excluded under this paragraph (c)(3). The provi-sions of this paragraph (c)(3) shall apply to exclude unusual grants made during any of the applicable periods de-scribed in this paragraph (c) or para-graph (d) of this section. See paragraph (c)(5) of this section as to reliance by a grantee organization upon an unusual grant ruling under this paragraph (c)(3). (4) Determining factors. In determining whether a particular contribution may be excluded under paragraph (c)(3) of this section, all pertinent facts and cir-cumstances will be taken into consid-eration. No single factor will nec-essarily be determinative. Among the factors to be considered are (i) Whether the contribution was made by any person (or persons stand-ing in a relationship to such person which is described in section 4946(a)(1)(C) through 4946(a)(1)(G)) who created the organization, previously contributed a substantial part of its support or endowment, or stood in a position of authority, such as a founda-tion manager (within the meaning of section 4946(b)), with respect to the or-ganization. A contribution made by a person other than those persons de-scribed in this paragraph (c)(4)(i) will ordinarily be given more favorable con-sideration than a contribution made by a person described in this paragraph (c)(4)(i); (ii) Whether the contribution was a bequest or an inter vivos transfer. A bequest will ordinarily be given more favorable consideration than an inter vivos transfer; (iii) Whether the contribution was in the form of cash, readily marketable securities, or assets which further the exempt purposes of the organization, such as a gift of a painting to a mu-seum; (iv) Except in the case of a new orga-nization, whether, prior to the receipt of the particular contribution, the or-ganization has carried on an actual program of public solicitation and ex-empt activities and has been able to at-tract a significant amount of public support; VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00118 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150109 Internal Revenue Service, Treasury 1.509(a)3 (v) Whether the organization may reasonably be expected to attract a sig-nificant amount of public support sub-sequent to the particular contribution. In this connection, continued reliance on unusual grants to fund an organiza-tions current operating expenses (as opposed to providing new endowment funds) may be evidence that the orga-nization cannot reasonably be expected to attract future support from the gen-eral public; (vi) Whether, prior to the year in which the particular contribution was received, the organization met the one- third support test described in para-graph (a)(2) of this section without the benefit of any exclusions of unusual grants pursuant to paragraph (c)(3) of this section; (vii) Whether neither the contributor nor any person standing in a relation-ship to such contributor which is de-scribed in section 4946(a)(1)(C) through 4946(a)(1)(G) continues directly or indi-rectly to exercise control over the or-ganization; (viii) Whether the organization has a representative governing body as de-scribed in 1.509(a)3(d)(3)(i); and (ix) Whether material restrictions or conditions (within the meaning of 1.5072(a)(7)) have been imposed by the transferor upon the transferee in con-nection with such transfer. (5) Grantors and contributors. Prior to the making of any grant or contribu-tion expected to meet the requirements for exclusion under paragraph (c)(3) of this section, a potential grantee orga-nization may request a determination whether such grant or contribution may be so excluded. Requests for such determination may be filed by the grantee organization in the time and manner specified by revenue procedure or other guidance published in the In-ternal Revenue Bulletin. The issuance of such determination will be at the sole discretion of the Commissioner. The organization must submit all in-formation necessary to make a deter-mination of the applicability of para-graph (c)(3) of this section, including all information relating to the factors described in paragraph (c)(4) of this section. If a favorable determination is issued, such determination may be re-lied upon by the grantor or contributor of the particular contribution in ques-tion for purposes of sections 170, 507, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522 and by the grantee organization for purposes of paragraph (c)(3) of this section. (6) Examples. The application of the principles set forth in this paragraph is illustrated by the examples as follows. For purposes of these examples, the term general public is defined as persons other than disqualified persons and other than persons from whom the foundation received gross receipts in excess of the greater of $5,000 or 1 per-cent of its support in any taxable year, the term gross investment income is as defined in section 509(e), and the term gross receipts is limited to receipts from activities which are not unrelated trades or businesses (within the mean-ing of section 513). Example 1. (i) For the years 2008 through 2012, X, an organization exempt under sec-tion 501(c)(3) that makes scholarship grants to needy students of a particular city, re-ceived support from the following sources: 2008: Gross receipts (general public) ..................................................... $35,000 Contributions (substantial contributors) ..................................... 36,000 Gross investment income .............................................................. 29,000 Total support .................................................................... 100,000 2009: Gross receipts (general public) ..................................................... 34,000 Contributions (substantial contributors) ..................................... 35,000 Gross investment income .............................................................. 31,000 Total support .................................................................... 100,000 2010: Gross receipts (general public) ..................................................... 35,000 Contributions (substantial contributors) ..................................... 30,000 VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00119 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150110 26 CFR Ch. I (4113 Edition) 1.509(a)3 Gross investment income .............................................................. 35,000 Total support .................................................................... 100,000 2011: Gross receipts (general public) ..................................................... 33,000 Contributions (substantial contributors) ..................................... 32,000 Gross investment income .............................................................. 35,000 Total support .................................................................... 100,000 2012: Gross receipts (general public) ..................................................... 31,000 Contributions (substantial contributors) ..................................... 39,000 Gross investment income .............................................................. 30,000 Total support .................................................................... 100,000 (ii) In applying section 509(a)(2) to the tax-able year 2012, on the basis of paragraph (c)(1)(i) of this section, the total amount of support from gross receipts from the general public ($168,000) for the period 2008 through 2012, was more than one third, and the total amount of support from gross investment in-come ($160,000) was less than one third, of Xs total support for the same period ($500,000). For the taxable years 2012 and 2013, X is therefore considered normally to receive more than one third of its support from the public sources described in section 509(a)(2)(A) and less than one third of its sup-port from items described in section 509(a)(2)(B). The fact that X received less than one third of its support from section 509(a)(2)(A) sources in 2012 and more than one third of its support from items described in section 509(a)(2)(B) in 2011 does not affect its status because it normally met the applica-ble tests over a five-year period. Example 2. Assume the same facts as in Ex-ample 1 except that in 2012, X also received an unexpected bequest of $50,000 from A, an elderly widow who was interested in encour-aging the work of X, but had no other rela-tionship to it. Solely by reason of the be-quest, A became a disqualified person. X used the bequest to create five new scholarships. Its operations otherwise remained the same. Under these circumstances, if As bequest is included in Xs support calculation, X could not meet the five-year support test because the total amount received from gross re-ceipts from the general public ($168,000) would not be more than one-third of its total support for the five-year period ($550,000). Be-cause A is a disqualified person, her bequest cannot be included in the numerator of the one-third support test under section 509(a)(2)(A). However, based on the factors set forth in paragraph (c)(4) of this section, As bequest may be excluded as an unusual grant under paragraph (c)(3) of this section. Therefore, X will be considered to have met the support test for the taxable years 2012 and 2013. Example 3. Y, an organization described in section 501(c)(3), was created by A, the holder of all the common stock in M corporation; B, As wife; and C, As business associate. The purpose of Y was to sponsor and equip ath-letic teams for underprivileged children in the community. Each of the three creators makes small cash contributions to Y. A, B, and C have been active participants in the affairs of Y since its creation. Y regularly raises small amounts of contributions through fundraising drives and selling ad-mission to some of the sponsored sporting events. The operations of Y are carried out on a small scale, usually being restricted to the sponsorship of two to four baseball teams of underprivileged children. In 2009, M re-capitalizes and creates a first and second class of 6 percent nonvoting preferred stock, most of which is held by A and B. In 2010, A contributes 49 percent of his common stock in M to Y. As contribution of Ms common stock was substantial and constitutes 90 per-cent of Ys total support for 2010. A combina-tion of the facts and circumstances described in paragraph (c)(4) of this section preclude As contribution of Ms common stock in 2010 from being excluded as an unusual grant under paragraph (c)(3) of this section for pur-poses of determining whether Y meets the one-third support test under section 509(a)(2). Example 4. (i) M is organized in 2009 to pro-mote the appreciation of ballet in a par-ticular region of the United States. Its prin-cipal activities consist of erecting a theater for the performance of ballet and the organi-zation and operation of a ballet company. M receives a determination letter that it is an organization described in section 501(c)(3) and that it is a public charity described in section 509(a)(2). The governing body of M consists of nine prominent unrelated citizens residing in the region who have either an ex-pertise in ballet or a strong interest in en-couraging appreciation of the art form. (ii) In 2010, Z, a private foundation, pro-poses to makes a grant of $500,000 in cash to VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00120 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150111 Internal Revenue Service, Treasury 1.509(a)3 M to provide sufficient capital for M to com-mence its activities. Although A, the creator of Z, is one of the nine members of Ms gov-erning body, was one of Ms original found-ers, and continues to lend his prestige to Ms activities and fund raising efforts, A does not, directly or indirectly, exercise any con-trol over M. M also receives a significant amount of support from a number of smaller contributions and pledges from other mem-bers of the general public. M charges admis-sion to the ballet performances to the gen-eral public. (iii) Although the support received in 2010 will not impact Ms status as a public char-ity for its first five taxable years, it will be relevant to the determination of whether M meets the one-third support test under sec-tion 509(a)(2) for the 2014 taxable year, using the computation period 2010 through 2014. Within the appropriate timeframe, M may submit a request for a private letter ruling that the $500,000 contribution from Z quali-fies as an unusual grant. (iv) Under the above circumstances, even though A was a founder and member of the governing body of M, M may exclude Zs con-tribution of $500,000 in 2010 as an unusual grant under paragraph (c)(3) of this section for purposes of determining whether M meets the one-third support test under section 509(a)(2) for 2014. Example 5. (i) Assume the same facts as Ex-ample 4(i) except that, in addition, in 2013, B, a widow, passes away and bequeaths $4 mil-lion to M. During 2009 through 2013, B made small contributions to M, none exceeding $10,000 in any year. During 2009 through 2013, M received approximately $450,000 from re-ceipts for admissions and contributions from the general public. At the time of Bs death, no person standing in a relationship to B de-scribed in section 4946(a)(1)(C) through 4946(a)(1)(G) was a member of Ms governing body. Bs bequest was in the form of cash and readily marketable securities. The only con-dition placed upon the bequest was that it be used by M to advance the art of ballet. (ii) Although the support received in 2013 will not impact Ms status as a public char-ity for its first five taxable years, it will be relevant to the determination of whether M meets the one-third support test under sec-tion 509(a)(2) for future years. Within the ap-propriate timeframe, M may submit a re-quest for a private letter ruling that the $4 million bequest from B qualifies as an un-usual grant. (iii) Under the above circumstances, M may exclude Bs bequest of $4 million in 2013 as an unusual grant under paragraph (c)(3) of this section for purposes of determining whether M meets the one-third support test under section 509(a)(2) for 2014 and subse-quent years. Example 6. (i) N is a research organization that was created by A in 2009 for the purpose of carrying on economic studies primarily through persons receiving grants from N and engaging in the sale of economic publica-tions. N received a determination letter that it is described in section 501(c)(3) and that it is a public charity described in 509(a)(2). Ns five-member governing body consists of A; As sons, B and C; and two unrelated econo-mists. In 2009, A made a contribution to N of $100,000 to help establish the organization. During 2009 through 2013, A made annual contributions to N averaging $20,000 a year. During the same period, N received annual contributions from members of the general public averaging $15,000 per year and receipts from the sale of its publications averaging $50,000 per year. In 2013, B made an inter vivos contribution to N of $600,000 in cash and readily marketable securities. (ii) Although the support received in 2013 will not impact Ns status as a public charity for its first five taxable years, it will be rel-evant to the determination of whether N meets the one-third support test under sec-tion 509(a)(2) for future years. In determining whether Bs contribution of $600,000 in 2013 may be excluded as an unusual grant, the support N received in 2009 through 2013 is rel-evant in considering the factor described in paragraph (c)(4)(vi) of this section, notwith-standing that N received a determination letter that it is described in section 509(a)(2). (iii) Under the above circumstances, in particular the facts that B is a disqualified person described in section 4946(a)(1)(D) and N does not have a representative governing body as described in paragraphs (c)(4)(viii) and (d)(3)(i) of this section, N cannot exclude Bs contribution of $600,000 in 2013 as an un-usual grant under paragraph (c)(3) of this section for purposes of determining whether N meets the one-third support test under section 509(a)(2) for 2014 and future years. Example 7. (i) O is an educational organiza-tion created in 2009. O received a determina-tion letter that it is described in section 501(c)(3) and that it is a public charity de-scribed in section 509(a)(2). The governing body of O has 9 members, consisting of A, a prominent civic leader, and 8 other unrelated civic leaders and educators in the commu-nity, all of whom participated in the cre-ation of O. During 2009 through 2013, the principal source of income for O has been re-ceipts from the sale of its educational peri-odicals. These sales have amounted to $200,000 for this period. Small contributions amounting to $50,000 have also been received during the same period from members of the governing body, including A, as well as other members of the general public. (ii) In 2013, A contributed $750,000 of the nonvoting stock of S, a closely held corpora-tion, to O. A retained a substantial portion of the voting stock of S. By a majority vote, the governing body of O decided to retain the S stock for a period of at least five years. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00121 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150112 26 CFR Ch. I (4113 Edition) 1.509(a)3 (iii) Although the support received in 2013 will not impact Os status as a public charity for its first five taxable years, it will be rel-evant to the determination of whether O meets the one-third support test under sec-tion 509(a)(2) for future years. In determining whether As contribution of the S stock in 2013 may be excluded as an unusual grant, the support O received in 2009 through 2013 is relevant in considering the factor described in paragraph (c)(4)(vi) of this section, not-withstanding that O received a determina-tion letter that it is described in section 509(a)(2). (iv) Under the above circumstances, in par-ticular the facts that A is a foundation man-ager within the meaning of section 4946(b) and As contribution is in the form of closely held stock, O cannot exclude As contribu-tion of the S stock in 2013 as an unusual grant under paragraph (c)(3) of this section for purposes of determining whether O meets the one-third support test under section 509(a)(2) for 2014 and future years. (d) Definition of normally; first five years of an organizations existence(1) In general. An organization will nor-mally meet the one-third support test and the not-more-than-one-third sup-port test during its first five taxable years as a section 501(c)(3) organization if the organization can reasonably be expected to meet the requirements of the one-third support test and the not- more-than-one-third support test dur-ing that period. With respect to an or-ganizations sixth taxable year, the general definition of normally in para-graph (c)(1) of this section applies. Al-ternatively, the organization shall be treated as normally meeting the one- third support test and the not-more- than-one-third support test for its sixth taxable year (but not its seventh taxable year) if it meets the one-third support test and the not-more-than- one-third support test under the defini-tion of normally set forth in paragraph (c)(1)(i) of this section for its fifth tax-able year (based on support received in its first through fifth taxable years). If a new publicly supported organization described under section 509(a)(2) cannot meet the requirements of the one-third support test or the not-more-than-one- third support test for its sixth taxable year using either the general definition of normally in paragraph (c)(1) of this section or the alternate rule above (ef-fectively failing to meet a public sup-port test for both its fifth and sixth years), it will be reclassified as a pri-vate foundation as of the first day of its sixth taxable year only for purposes of sections 507, 4940, and 6033. Such an organization must file a Form 990PF, Return of Private Foundation or Sec-tion 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Founda-tion, and is liable for the net invest-ment tax imposed by section 4940 and, if applicable, the private foundation termination tax imposed by section 507(c), for its sixth taxable year. Begin-ning the first day of its seventh taxable year, the organization will be treated as a private foundation for all pur-poses. (2) Basic consideration. In determining whether an organization can reason-ably be expected (within the meaning of paragraph (c)(1)(i) of this section) to meet the one-third support test under section 509(a)(2)(A) and the not-more- than-one-third support test under sec-tion 509(a)(2)(B) described in paragraph (a) of this section during its first five taxable years, the basic consideration is whether its organizational structure, current or proposed programs or activi-ties, and actual or intended method of operation are such as to attract the type of broadly based support from the general public, public charities, and governmental units that is necessary to meet such tests. The factors that are relevant to this determination, and the weight accorded to each of them, may differ from case to case, depending on the nature and functions of the or-ganization. An organization cannot reasonably be expected to meet the one-third support test and the not- more-than-one-third support test where the facts indicate that an orga-nization is likely during its first five taxable years to receive less than one- third of its support from permitted sources (subject to the limitations of paragraph (b) of this section) or to re-ceive more than one-third of its sup-port from items described in section 509(a)(2)(B). (3) Factors taken into account. All per-tinent facts and circumstances shall be taken into account under paragraph (d)(2) of this section in determining whether the organizational structure, programs or activities, and method of operation of an organization are such VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00122 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150113 Internal Revenue Service, Treasury 1.509(a)3 as to enable it to meet the tests under section 509(a)(2) during its first five taxable years. Some of the pertinent factors are: (i) Whether the organization has or will have a representative governing body which is comprised of public offi-cials, or individuals chosen by public officials acting in their capacity as such; of persons having special knowl-edge in the particular field or dis-cipline in which the organization is op-erating; of community leaders, such as elected officials, clergymen, and edu-cators; or, in the case of a membership organization, of individuals elected pursuant to the organizations gov-erning instrument or bylaws by a broadly based membership. This char-acteristic does not exist if the member-ship of the organizations governing body is such as to indicate that it rep-resents the personal or private inter-ests of disqualified persons, rather than the interests of the community or the general public. (ii) Whether a substantial portion of the organizations initial funding is to be provided by the general public, by public charities, or by government grants, rather than by a limited num-ber of grantors or contributors who are disqualified persons with respect to the organization. The fact that the organi-zation plans to limit its activities to a particular community or region or to a special field which can be expected to appeal to a limited number of persons will be taken into consideration in de-termining whether those persons pro-viding the initial support for the orga-nization are representative of the gen-eral public. On the other hand, the sub-sequent sources of funding which the organization can reasonably expect to receive after it has become established and fully operational will also be taken into account. (iii) Whether a substantial proportion of the organizations initial funds are placed, or will remain, in an endow-ment, and whether the investment of such funds is unlikely to result in more than one third of its total support being received from items described in section 509(a)(2)(B). (iv) In the case of an organization that carries on fundraising activities, whether the organization has developed a concrete plan for solicitation of funds from the general public on a commu-nity or area-wide basis; whether any steps have been taken to implement such plan; whether any firm commit-ments of financial or other support have been made to the organization by civic, religious, charitable, or similar groups within the community; and whether the organization has made any commitments to, or established any working relationships with, those orga-nizations or classes of persons intended as the future recipients of its funds. (v) In the case of an organization that carries on community services, such as combating community deterio-ration in an economically depressed area that has suffered a major loss of population and jobs, whether the orga-nization has a concrete program to carry out its work in the community; whether any steps have been taken to implement that program; whether it will receive any part of its funds from a public charity or governmental agen-cy to which it is in some way held ac-countable as a condition of the grant or contribution; and whether it has en-listed the sponsorship or support of other civic or community leaders in-volved in community service programs similar to those of the organization. (vi) In the case of an organization that carries on educational or other ex-empt activities for, or on behalf of, members, whether the solicitation for dues-paying members is designed to en-roll a substantial number of persons in the community, area, profession, or field of special interest (depending on the size of the area and the nature of the organizations activities); whether membership dues for individual (rather than institutional) members have been fixed at rates designed to make mem-bership available to a broad cross-sec-tion of the public rather than to re-strict membership to a limited number of persons; and whether the activities of the organization will be likely to ap-peal to persons having some broad common interest or purpose, such as educational activities in the case of alumni associations, musical activities in the case of symphony societies, or civic affairs in the case of parent- teacher associations. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00123 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150114 26 CFR Ch. I (4113 Edition) 1.509(a)3 (vii) In the case of an organization that provides goods, services, or facili-ties, whether the organization is or will be required to make its services, facilities, performances, or products available (regardless of whether a fee is charged) to the general public, public charities, or governmental units, rath-er than to a limited number of persons or organizations; whether the organiza-tion will avoid executing contracts to perform services for a limited number of firms or governmental agencies or bureaus; and whether the service to be provided is one which can be expected to meet a special or general need among a substantial portion of the gen-eral public. (4) Example. The application of this paragraph (d) may be illustrated by the following example: Example. (i) Organization X was formed in January 2008 and uses a taxable year ending December 31. After September 9, 2008, and be-fore December 31, 2008, Organization X filed Form 1023 requesting recognition of exemp-tion as an organization described in section 501(c)(3) and in section 509(a)(2). In its appli-cation, Organization X established that it can reasonably be expected to operate as a publicly supported organization under para-graph (d) of this section. Subsequently, Orga-nization X received a ruling or determina-tion letter that it is an organization de-scribed in sections 501(c)(3) and 509(a)(2) ef-fective as of the date of its formation. (ii) Organization X is described in section 509(a)(2) for its first five taxable years (for the taxable years ending December 31, 2008, through December 31, 2012). (iii) Organization X can qualify as a pub-licly supported organization beginning with the taxable year ending December 31, 2013, if Organization X can meet the requirements of either 1.170A9(f)(2) or 1.170A9(f)(3) or paragraphs (a) and (b) of this section for the taxable years ending December 31, 2009, through December 31, 2013, or for the taxable years ending December 31, 2008, through De-cember 31, 2012. (e) Determinations on foundation classi-fication and reliance(1) A ruling or de-termination letter that an organiza-tion is described in section 509(a)(2) may be issued to an organization. Such determination may be made in con-junction with the recognition of the or-ganizations tax-exempt status or at such other time as the organization be-lieves it is described in section 509(a)(2). The ruling or determination letter that the organization is de-scribed in section 509(a)(2) may be re-voked if, upon examination, the organi-zation has not met the requirements of this section. The ruling or determina-tion letter that the organization is de-scribed in section 509(a)(2) also may be revoked if the organizations applica-tion for a ruling or determination con-tained one or more material misstatements or omissions of fact or such application was part of a scheme or plan to avoid or evade any provision of the Code. The revocation of the de-termination that an organization is de-scribed in section 509(a)(2) does not pre-clude revocation of the determination that the organization is described in section 501(c)(3). (2) Status of grantors or contributors. (i) For purposes of sections 170, 507, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522, grantors and con-tributors may rely upon a determina-tion letter or ruling that an organiza-tion is described in section 509(a)(2) until the IRS publishes notice of a change of status (for example, in the Internal Revenue Bulletin or Publica-tion 78, Cumulative List of Organiza-tions described in Section 170(c) of the Internal Revenue Code of 1986, which can be searched at http://www.irs.gov). For this purpose, grantors or contribu-tors may also rely on an advance rul-ing that expires on or after June 9, 2008. However, a grantor or contributor may not rely on such an advance ruling or any determination letter or ruling if the grantor or contributor was respon-sible for, or aware of, the act or failure to act that resulted in the organiza-tions loss of classification under sec-tion 509(a)(2) or acquired knowledge that the IRS had given notice to such organization that it would be deleted from such classification. (ii) A grantor or contributor (other than one of the organizations found-ers, creators, or foundation managers (within the meaning of section 4946(b))) will not be considered to be responsible for, or aware of, the act or failure to act that resulted in the loss of the or-ganizations publicly supported classi-fication under section 509(a)(2) if such grantor or contributor has made such grant or contribution in reliance upon VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00124 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150115 Internal Revenue Service, Treasury 1.509(a)3 a written statement by the grantee or-ganization that such grant or contribu-tion will not result in the loss of such organizations classification as not a private foundation under section 509(a). Such statement must be signed by a re-sponsible officer of the grantee organi-zation and must set forth sufficient in-formation, including a summary of the pertinent financial data for the five taxable years immediately preceding the current taxable year, to assure a reasonably prudent person that his grant or contribution will not result in the loss of the grantee organizations classification as a publicly supported organization under section 509(a). If a reasonable doubt exists as to the effect of such grant or contribution, or if the grantor or contributor is one of the or-ganizations founders, creators, or foundation managers, the procedure for requesting a determination letter set forth in paragraph (c)(5) of this section may be followed by the grantee organi-zation for the protection of the grantor or contributor. (3) Examples. The provisions of this paragraph (e) may be illustrated by the following examples: Example 1. Y, a calendar year organization described in section 501(c)(3), is created in February 2008 for the purpose of displaying African art. On its exemption application Y shows, under penalties of perjury, that it can reasonably, in accordance with the require-ments of paragraph (d) of this section, expect to receive support from the public in 2008 through 2012 that will satisfy the one-third support and not-more-than-one-third support tests described in section 509(a)(2) for its first five taxable years, 2008 through 2012. Y may therefore receive a determination that it meets the requirements of paragraph (a) of this section for its first five taxable years (2008, 2009, 2010, 2011, and 2012), regardless of the public support Y in fact receives during this period. Example 2. Z, a calendar year organization described in section 501(c)(3), is created in July 2008. On its exemption application Z shows, under penalties of perjury, that it can reasonably, in accordance with the require-ments of paragraph (d) of this section, expect to receive support from the public in 2008 through 2012 that will satisfy the one-third support and not-more-than-one-third support tests described in section 509(a)(2) for its first five taxable years, 2008 through 2012. Z receives a determination that it is described in section 509(a)(2). However, the support ac-tually received from the public over Zs first five taxable years (2008 through 2012) does not satisfy the one-third support and not- more-than-one-third support tests described in section 509(a)(2). Moreover, the support Z receives from 2009 through 2013, also does not meet the one-third support and not-more- than-one-third support tests described in sec-tion 509(a)(2). Z is described in section 509(a)(2) during its first five years for all pur-poses. However, because Z has not met the requirements of paragraph (a) of this section for either 2008 through 2012 or 2009 through 2013, Z is not described in section 509(a)(2) for its taxable year 2013. If Z is not described in section 509(a)(1), section 509(a)(3), or section 509(a)(4), then Z will be reclassified as a pri-vate foundation as of the first day of 2013. However, for 2013, Z will be treated as a pri-vate foundation only for purposes of sections 507, 4940 and 6033. Z must file Form 990PF and will be liable for the net investment tax imposed by section 4940 and, if applicable, the private foundation termination tax im-posed by section 507(c) for 2013. For 2014 and succeeding years, Z will be treated as a pri-vate foundation for all purposes (except as provided in paragraph (e)(2) of this section with respect to grantors and contributors). (f) Gifts and contributions distinguished from gross receipts(1) In general. In de-termining whether an organization normally receives more than one-third of its support from permitted sources, all gifts and contributions (within the meaning of section 509(a)(2)(A)(i)) re-ceived from permitted sources, are in-cludible in the numerator of the sup-port fraction in each taxable year. However, gross receipts (within the meaning of section 509(a)(2)(A)(ii)) from admissions, sales of merchandise, per-formance of services, or furnishing of facilities, in an activity which is not an unrelated trade or business, are in-cludible in the numerator of the sup-port fraction in any taxable year only to the extent that such gross receipts do not exceed the limitation with re-spect to the greater of $5,000 or 1 per-cent of support which is describing paragraph (b) of this section. The terms gifts and contributions shall, for purposes of section 509(a)(2), have the same meaning as such terms have under section 170(c) and also include bequests, legacies, devises, and trans-fers within the meaning of section 2055 or 2106(a)(2). Thus, for purposes of sec-tion 509(a)(2)(A), any payment of money or transfer of property without adequate consideration shall be consid-ered a gift or contribution. Where pay-ment is made or property transferred VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00125 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150116 26 CFR Ch. I (4113 Edition) 1.509(a)3 as consideration for admissions, sales of merchandise, performance of serv-ices, or furnishing of facilities to the donor, the status of the payment or transfer under section 170(c) shall de-termine whether and to what extent such payment or transfer constitutes a gift or contribution under section 509(a)(2)(A)(i) as distinguished from gross receipts from related activities under section 509(a)(2)(A)(ii). For pur-poses of section 509(a)(2), the term con-tributions includes qualified sponsor-ship payments (as defined in 1.5134) in the form of money or property (but not services). (2) Valuation of property. For purposes of section 509(a)(2), the amount includ-ible in computing support with respect to gifts, grants or contributions of property or use of such property shall be the fair market or rental value of such property at the date of such gift or contribution. (3) Examples. The provisions of this paragraph (f) may be illustrated by the following examples: Example 1. P is a local agricultural club de-scribed in section 501(c)(3). In order to en-courage interest and proficiency by young people in farming and raising livestock, it makes awards at its annual fair for out-standing specimens of produce and livestock. Most of these awards are cash or other prop-erty donated by local businessmen. When the awards are made, the donors are given rec-ognition for their donations by being identi-fied as the donor of the award. The recogni-tion given to donors is merely incidental to the making of the award to worthy young-sters. For these reasons, the donations will constitute contributions for purposes of sec-tion 509(a)(2)(A)(i). The amount includible in computing support with respect to such con-tributions is equal to the cash contributed or the fair market value of other property on the dates contributed. Example 2. Q, a performing arts center, en-ters into a contract with a large company to be the exclusive sponsor of the centers the-atrical events. The company makes a pay-ment of cash and products in the amount of $100,000 to Q, and in return, Q agrees to make a broadcast announcement thanking the company before each show and to provide $2,000 of advertising in the shows program (2% of $100,000 is $2,000). The announcement constitutes use or acknowledgment pursuant to section 513(i)(2). Because the value of the advertising does not exceed 2% of the total payment, the entire $100,000 is a qualified sponsorship payment under section 513(i), and $100,000 is treated as a contribution for purposes of section 509(a)(2)(A)(i). Example 3. R, a charity, enters into a con-tract with a law firm to be the exclusive sponsor of the charitys outreach program. Instead of making a cash payment, the law firm agrees to perform $100,000 of legal serv-ices for the charity. In return, R agrees to acknowledge the law firm in all its informa-tional materials. The total fair market value of the legal services, or $100,000, is a qualified sponsorship payment under section 513(i), but no amount is treated as a contribution under section 509(a)(2)(A)(i) because the con-tribution is of services. (g) Grants distinguished from gross re-ceipts(1) In general. In determining whether an organization normally re-ceives more than one-third of its sup-port from public sources, all grants (within the meaning of section 509(a)(2)(A)(i)) received from permitted sources are includible in full in the nu-merator of the support fraction in each taxable year. However, gross receipts (within the meaning of section 509(a)(2)(A)(ii)) from admissions, sales of merchandise, performance of serv-ices, or furnishing of facilities, in an activity which is not an unrelated trade or business, are includible in the numerator of the support fraction in any taxable year only to the extent that such gross receipts do not exceed the limitation with respect to the greater of $5,000 or 1 percent of support which is described in paragraph (b) of this section. A grant is normally made to encourage the grantee organization to carry on certain programs or activi-ties in furtherance of its exempt pur-poses. It may contain certain terms and conditions imposed by the grantor to insure that the grantees programs or activities are conducted in a manner compatible with the grantors own pro-grams and policies and beneficial to the public. The grantee may also per-form a service or produce a work prod-uct which incidentally benefits the grantor. Because of the imposition of terms and conditions, the frequent similarlity of public purposes of grant-or and grantee, and the possibility of benefit resulting to the grantor, amounts received as grants for the car-rying on of exempt activities are some-times difficult to distinguish from amounts received as gross receipts from the carrying on of exempt activities. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00126 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150117 Internal Revenue Service, Treasury 1.509(a)3 The fact that the agreement, pursuant to which payment is made, is des-ignated a contract or a grant is not con-trolling for purposes of classifying the payment under section 509(a)(2). (2) Distinguishing factors. For pur-poses of section 509(a)(2)(A)(ii), in dis-tinguishing the term gross receipts from the term grants, the term gross receipts means amounts received from an activ-ity which is not an unrelated trade or business, if a specific service, facility, or product is provided to serve the di-rect and immediate needs of the payor, rather than primarily to confer a di-rect benefit upon the general public. In general, payments made primarily to enable the payor to realize or receive some economic or physical benefit as a result of the service, facility, or prod-uct obtained will be treated as gross re-ceipts with respect to the payee. The fact that a profitmaking organization would, primarily for its own economic or physical betterment, contract with a nonprofit organization for the ren-dition of a comparable service, facility or product from such organization con-stitutes evidence that any payments received by the nonprofit payee organi-zation (whether from a governmental unit, a nonprofit or a profitmaking or-ganization) for such services, facilities or products are primarily for the eco-nomic or physical benefit of the payor and would therefore be considered gross receipts, rather than grants with respect to the payee organization. For exam-ple, if a nonprofit hospital described in section 170(b)(1)(A)(iii) engages an ex-empt research and development organi-zation to develop a more economical system of preparing food for its own patients and personnel, and it can be established that a hospital operated for profit might engage the services of such an organization to perform a simi-lar benefit for its economic better-ment, such fact would constitute evi-dence that the payments received by the research and development organi-zation constitute gross receipts, rather than grants. Research leading to the de-velopment of tangible products for the use or benefit of the payor will gen-erally be treated as a service provided to serve the direct and immediate needs of the payor, while basic research or studies carried on in the physical or social sciences will generally be treat-ed as primarily to confer a direct ben-efit upon the general public. (3) Examples. The application of this paragraph may be illustrated by the following examples: Example 1. M, a nonprofit research organi-zation described in section 501(c)(3), engages in some contract research. It receives funds from the government to develop a specific electronic device needed to perfect articles of space equipment. The initiative for the project came solely from the government. Furthermore, the government could have contracted with profitmaking research orga-nizations which carry on similar activities. The funds received from the government for this project are gross receipts and do not constitute grants within the meaning of sec-tion 509(a)(2)(A)(i). M provided a specific product at the governments request and thus was serving the direct and immediate needs of the payor within the meaning of subparagraph (2) of this paragraph. Example 2. N is a nonprofit educational or-ganization described in section 501(c)(3). Its principal activity is to operate institutes to train employees of various industries in the principles of management and administra-tion. The government pays N to set up a spe-cial institute for certain government em-ployees and to train them over a 2-year pe-riod. Management training is also provided by profitmaking organizations. The funds re-ceived are included as gross receipts. The par-ticular services rendered were to serve the direct and immediate needs of the govern-ment in the training of its employees within the meaning of subparagraph (2) of this para-graph. Example 3. The Office of Economic Oppor-tunity makes a community action program grant to O, an organization described in sec-tion 509(a)(1). O serves as a delegate agency of OEO for purposes of financing a local com-munity action program. As part of this pro-gram, O signs an agreement with X, an edu-cational and charitable organization de-scribed in section 501(c)(3), to carry out a housing program for the benefit of poor fami-lies. Pursuant to this agreement, O pays X out of the funds provided by OEO to build or rehabilitate low income housing and to pro-vide advisory services to other nonprofit or-ganizations in order for them to meet simi-lar housing objectives, all on a nonprofit basis. Payments made from O to X con-stitute grants for purposes of section 509(a)(2)(A) because such program is carried on primarily for the direct benefit of the community. Example 4. P is an educational institute de-scribed in section 501(c)(3). It carries on stud-ies and seminars to assist institutions of higher learning. It receives funds from the VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00127 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150118 26 CFR Ch. I (4113 Edition) 1.509(a)3 government to research and develop a pro-gram of black studies for institutions of higher learning. The performance of such a service confers a direct benefit upon the pub-lic. Because such program is carried on pri-marily for the direct benefit of the public, the funds are considered a grant. Example 5. Q is an organization described in section 501(c)(3) which carries on medical re-search. Its efforts have primarily been di-rected toward cancer research. Q sought funds from the government for a particular project being contemplated in connection with its work. In order to encourage its ac-tivities, the government gives Q the sum of $25,000. The research project sponsored by government funds is primarily to provide di-rect benefit to the general public, rather than to serve the direct and immediate needs of the government. The funds are therefore considered a grant. Example 6. R is a public service organiza-tion described in section 501(c)(3) and com-posed of State and local officials involved in public works activities. The Bureau of Solid Waste, Management of the Department of Health, Education, and Welfare paid R to study the feasibility of a particular system for disposal of solid waste. Upon completion of the study, R was required to prepare a final report setting forth its findings and conclusions. Although R is providing the Bu-reau of Solid Waste Management with a final report, such report is the result of basic re-search and study in the physical sciences and is primarily to provide direct benefit to the general public by serving to further the gen-eral functions of government, rather than a direct and immediate governmental needs. The funds paid to R are therefore a grant within the meaning of section 509(a)(2). Example 7. R is the public service organiza-tion referred to in example 6. W, a munici-pality described in section 170(c)(1), decides to construct a sewage disposal plant. W pays R to study a number of possible locations for such plant and to make recommendations to W, based upon a number of factors, as to the best location. W instructed R that in making its recommendation, primary consideration should be given to minimizing the costs of the project to W. Since the study commis-sioned by W was primarily directed toward producing an economic benefit to W in the form of minimizing the costs of its project, the services rendered are treated as serving Ws direct and immediate needs and are in-cludible as gross receipts by R. Example 8. S in an organization described in section 501(c)(3). It was organized and is operated to further African development and strengthen understanding between the United States and Africa. To further these purposes, S receives funds from the Agency for International Development and the De-partment of State under which S is required to carry out the following programs: Selec-tion, transportation, orientation, counseling, and language training of African students admitted to American institutions of higher learning; payment of tuition, other fees, and maintenance of such students; and operation of schools and vocational training programs in underdeveloped countries for residents of those countries. Since the programs carried on by S are primarily to provide direct ben-efit to the general public, all of the funds re-ceived by S from the Federal agencies are considered grants within the meaning of sec-tion 509(a)(2). (h) Definition of membership fees(1) General rule. For purposes of section 509(a)(2), the fact that a membership organization provides services, admis-sions, facilities, or merchandise to its members as part of its overall activi-ties will not, in itself, result in the classification of fees received from members as gross receipts rather than membership fees. If an organization uses membership fees as a means of selling admissions, merchandise, services, or the use of facilities to members of the general public who have no common goal or interest (other than the desire to purchase such admissions, merchan-dise, services, or use of facilities), then the income received from such fees shall not constitute membership fees under section 509(a)(2)(A)(i), but shall, if from a related activity, constitute gross receipts under section 509(a)(2)(A)(ii). On the other hand, to the extent the basic purpose for mak-ing the payment is to provide support for the organization rather than to purchase admissions, merchandise, services, or the use of facilities, the in-come received from such payment shall constitute membership fees. (2) Examples. The provisions of this paragraph may be illustrated by the following examples: Example 1. M is a symphony society de-scribed in section 501(c)(3). Its primary pur-pose is to support the local symphony or-chestra. The organization has three classes of membership. Contributing members pay annual dues of $10, sustaining members pay $25, and honorary members pay $100. The dues are placed in a maintenance fund which is used to provide financial assistance in un-derwriting the orchestras annual deficit. Members have the privilege of purchasing subscriptions to the concerts before they go on sale to the general public, but must pay the same price as any other member of the public. They also are entitled to attend a VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00128 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150119 Internal Revenue Service, Treasury 1.509(a)3 number of rehearsals each season without charge. Under these circumstances, Ms re-ceipts from the members constitute member-ship fees for purposes of section 509(a)(2)(A)(i). Example 2. N is a theater association de-scribed in section 501(c)(3). Its purpose is to support a repertory company in the commu-nity in order to make live theatrical per-formances available to the public. The orga-nization sponsors six plays each year. Mem-bers of the organization are entitled to a sea-son subscription to the plays. The fee paid as dues approximates the retail price of the six plays, less a 10-percent discount. Tickets to each performance are also sold directly to the general public. The organization also holds a series of lectures on the theater which members may attend. Under these cir-cumstances, the fees paid by members as dues will be considered gross receipts from a related activity. Although the fees are des-ignated as membership fees, they are actu-ally admissions to a series of plays. (i) Bureau defined(1) In general. The term any bureau or similar agency of a governmental unit (within the meaning of section 509(a)(2)(A)(ii)), refers to a specialized operating unit of the execu-tive, judicial, or legislative branch of government where business is con-ducted under certain rules and regula-tions. Since the term bureau refers to a unit functioning at the operating, as distinct from the policymaking, level of government, it is normally descrip-tive of a subdivision of a department of government. The term bureau, for pur-poses of section 509(a)(2)(A)(ii), would therefore not usually include those lev-els of government which are basically policymaking or administrative, such as the office of the Secretary or Assist-ant Secretary of a department, but would consist of the highest oper-ational level under such policymaking or administrative levels. Each subdivi-sion of a larger unit within the Federal Government, which is headed by a Presidential appointee holding a posi-tion at or above Level V of the Execu-tive Schedule under 5 U.S.C. 5316, will normally be considered an administra-tive or policymaking, rather than an operating, unit. Amounts received from a unit functioning at the policymaking or administrative level of government will be treated as received from one bu-reau or similar agency of such unit. Units of a governmental agency above the operating level shall be aggregated and considered a separate bureau for this purpose. Thus, an organization re-ceiving gross receipts from both a pol-icymaking or administrative unit and an operational unit of a department will be treated as receiving gross re-ceipts from two bureaus within the meaning of section 509(a)(2)(A)(ii). For purposes of this subparagraph, the De-partments of Air Force, Army, and Navy are separate departments and each is considered as having its own policymaking, administrative, and op-erating units. (2) Examples. The provisions of this paragraph may be illustrated by the following examples: Example 1. The Bureau of Health Insurance is considered a bureau within the meaning of section 509(a)(2)(A)(ii). It is a part of the De-partment of Health, Education, and Welfare, whose Secretary performs a policymaking function, and is under the Social Security Administration, which is basically an admin-istrative unit. The Bureau of Health Insur-ance is in the first operating level within the Social Security Administration. Similarly, the National Cancer Institute would be con-sidered a bureau, as it is an operating part of the National Institutes of Health within the Department of Health, Education, and Wel-fare. Example 2. The Bureau for Africa and the Bureau for Latin America are considered bu-reaus within the meaning of section 509(a)(2)(A)(ii). Both are separate operating units under the administrator of the Agency for International development, a policy-making official. If an organization received gross receipts from both of these bureaus, the amount of gross receipts received from each would be subject to the greater of $5,000 or 1 percent limitation under section 509(a)(2)(A)(ii). Example 3. The Bureau of International Af-fairs of the Civil Aeronautics Board is con-sidered a bureau within the meaning of sec-tion 509(a)(2)(A)(ii). It is an operating unit under the administrative office of the Execu-tive Director. The subdivisions of the Bureau of International Affairs are Geographic Areas and Project Development Staff. If an organization received gross receipts from these subdivisions, the total gross receipts from these subdivisions would be considered gross receipts from the same bureau, the Bu-reau of International Affairs, and would be subject to the greater of $5,000 or 1 percent limitation under section 509(a)(2)(A)(ii). VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00129 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150120 26 CFR Ch. I (4113 Edition) 1.509(a)3 Example 4. The Department of Mental Health, a State agency which is an oper-ational part of State Xs Department of Pub-lic Health, is considered a bureau. The De-partment of Public Health is basically an ad-ministrative agency and the Department of Mental Health is at the first operational level within it. Example 5. The Aeronautical Systems Divi-sion of the Air Force Systems Command, and other units on the same level, are considered separate bureaus with the meaning of section 509(a)(2)(A)(ii). They are part of the Depart-ment of the Air Force which is a separate de-partment for this purpose, as are the Army and Navy. The Secretary and the Under Sec-retary of the Air Force perform the policy-making function, the Chief of Staff and the Air Force Systems Command are basically administrative, having a comprehensive complement of staff functions to provide ad-ministration for the various divisions. The Aeronautical Systems Division and other units on the same level are thus the first op-erating level, as evidenced by the fact that they are the units that let contracts and per-form the various operating functions. Example 6. The Division of Space Nuclear Systems, the Division of Biology and Medi-cine, and other units on the same level with-in the Atomic Energy Commission are each separate bureaus within the meaning of sec-tion 509(a)(2)(A)(ii). The Commissioners (which make up the Commission) are the pol-icymakers. The general manager and the various assistant general managers perform the administrative function. The various di-visions perform the operating function as evidenced by the fact that each has separate programs to pursue and contracts specifi-cally for these various programs. (j) Grants from public charities(1) General rule. For purposes of the one- third support test in section 509(a)(2)(A), grants (as defined in para-graph (g) of this section) received from an organization described in section 509(a)(1) (hereinafter referred to in this subparagraph as a public charity) are generally includible in full in com-puting the numerator of the recipients support fraction of the taxable year in question. It is sometimes necessary to determine whether the recipient of a grant from a public charity has re-ceived such support from the public charity as a grant, or whether the re-cipient has in fact received such sup-port as an indirect contribution from a donor to the public charity. If the amount received is considered a grant from the public charity, it is fully in-cludible in the numerator of the sup-port fraction under section 509(a)(2)(A). However, if the amount received is con-sidered to be an indirect contribution from one of the public charitys donors which has passed through the public chairty to the recipient organization, such amount will retain its character as a contribution from such donor and, if, for example, the donor is a substan-tial contributor (as defined in section 507(d)(2)) with respect to the ultimate recipient, such amount shall be ex-cluded from the numerator of the sup-port fraction under section 509(a)(2). If a public charity makes both an indi-rect contribution from its donor and an additional grant to the ultimate recipi-ent, the indirect contribution shall be treated as made first. (2) Indirect contributions. For purposes of subparagraph (1) of this paragraph, an indirect contribution is one which is expressly or impliedly ear-marked by the donor as being for, or for the ben-efit of, a particular recipient (rather than for a particular purpose). (3) Examples. The provisions of this paragraph may be illustrated by the following examples: Example 1. M, a national foundation for the encouragement of the musical arts, is an or-ganization described in section 170(b)(1)(A)(vi). A gives M a donation of $5,000 without imposing any restrictions or condi-tions upon the gift. M subsequently makes a $5,000 grant to X, an organization devoted to giving public performances of chamber music. Since the grant to X is treated as being received from M, it is fully includible in the numerator of Xs support fraction for the taxable year of receipt. Example 2. Assume M is the same organiza-tion described in example 1. B gives M a do-nation of $10,000, but requires that M spend the money for the purpose of supporting or-ganizations devoted to the advancement of contemporary American music. M has com-plete discretion as to the organizations of the type described to which it will make a grant. M decides to make grants of $5,000 each to Y and Z, both being organizations de-scribed in section 501(c)(3) and devoted to furthering contemporary American music. Since the grants to Y and Z are treated as being received from M, Y and Z may each in-clude one of the $5,000 grants in the numer-ator of its support fraction for purposes of section 509(a)(2)(A). Although the donation to M was conditioned upon the use of the funds for a particular purpose, M was free to select the ultimate recipient. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00130 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150121 Internal Revenue Service, Treasury 1.509(a)3 Example 3. N is a national foundation for the encouragement of art and is an organiza-tion described in section 170(b)(1)(A)(vi). Grants to N are permitted to be earmarked for particular purposes. O, which is an art workshop devoted to training young artists and claiming status under section 509(a)(2), persuades C, a private foundation, to make a grant of $25,000 to N. C is a disqualified per-son with respect to O. C made the grant to N with the understanding that N would be bound to make a grant to O in the sum of $25,000, in addition to a matching grant of Ns funds to O in the sum of $25,000. Only the $25,000 received directly from N is considered a grant from N. The other $25,000 is deemed an indirect contribution from C to O and is to be excluded from the numerator of Os support fraction. (k) Method of accounting. For pur-poses of section 509(a)(2), an organiza-tions support will be determined under the method of accounting on the basis of which the organization regularly computes its income in keeping its books under section 446. For example, if a grantor makes a grant to an orga-nization payable over a term of years, such grant will be includible in the support fraction of the grantee organi-zation under the method of accounting on the basis of which it regularly com-putes its income in keeping its books under section 446. (l) Gross receipts from section 513(a) (1), (2), or (3) activities. For purposes of sec-tion 509(a)(2)(A)(ii), gross receipts from activities described in section 513(a) (1), (2), or (3) will be considered gross receipts from activities which are not unrelated trade or business. (m) Gross receipts distinguished from gross investment income. (1) For purposes of section 509(a)(2), where the chari-table purpose of an organization de-scribed in section 501(c)(3) is accom-plished through the furnishing of facili-ties for a rental fee or loans to a par-ticular class of persons, such as aged, sick, or needy persons, the support re-ceived from such persons will be con-sidered gross receipts (within the mean-ing of section 509(d)(2)) from an activ-ity which is not an unrelated trade or business, rather than gross investment income. However, if such organization also furnishes facilities or loans to per-sons who are not members of such class and such furnishing does not con-tribute importantly to the accomplish-ment of such organizations exempt purposes (aside from the need of such organization for income or funds or the use it makes of the profits derived), the support received from such furnishing will be considered rents or interest and therefore will be treated as gross invest-ment income within the meaning of sec-tion 509(d)(4), unless such income is in-cluded in computing the tax imposed by section 511. (2) The provisions of this paragraph may be illustrated by the following ex-ample: Example. X, an organization described in section 501(c)(3), is organized and operated to provide living facilities for needy widows of deceased servicemen. X charges such widows a small rental fee for the use of such facili-ties. Since X is accomplishing its exempt purpose through the rental of such facilities, the support received from the widows is con-sidered gross receipts within the meaning of section 509(d)(2). However, if X rents part of its facilities to persons having no relation-ship to Xs exempt purpose, the support re-ceived from such rental will be considered gross investment income within the meaning of section 509(d)(4), unless such income is in-cluded in computing the tax imposed by sec-tion 511. (n) Transition rules. (1) An organiza-tion that received an advance ruling, that expires on or after June 9, 2008, that it will be treated as an organiza-tion described in section 509(a)(2) will be treated as meeting the requirements of paragraph (d)(1) of this section for the first five taxable years of its exist-ence as a section 501(c)(3) organization unless the IRS issued to the organiza-tion a proposed determination prior to September 9, 2008, that the organiza-tion is not described in sections 170(b)(1)(A)(vi) and 509(a)(1) or in sec-tion 509(a)(2). (2) Paragraph (d)(1) of this section shall not apply to an organization that received an advance ruling that expired prior to June 9, 2008, and that did not timely file with the IRS the required information to establish that it is an organization described in sections 170(b)(1)(A)(vi) and 509(a)(1) or in sec-tion 509(a)(2). (3) An organization that fails to meet a public support test for its first tax-able year beginning on or after Janu-ary 1, 2008, under the regulations in this section may use the prior test set forth in 1.509(a)3(a)(2) and 1.509(a) 3(a)(3) or 1.170A9(e)(2) or 1.170A VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00131 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150122 26 CFR Ch. I (4113 Edition) 1.509(a)4 9(e)(3) as in effect before September 9, 2008, (as contained in 26 CFR part 1 re-vised April 1, 2008) to determine wheth-er the organization may be publicly supported for its 2008 taxable year based on its satisfaction of a public support test for taxable year 2007, com-puted over the period 2003 through 2006. (4) Examples. The application of this paragraph (n) may be illustrated by the following examples: Example 1. (i) Organization M was formed in January 2004, and uses a taxable year end-ing June 30. Organization M received an ad-vance ruling letter that it is recognized as an organization described in section 501(c)(3) ef-fective as of the date of its formation and that it is treated as a publicly supported or-ganization under section 509(a)(2) during the five-year advance ruling period that will end on June 30, 2008. This date is on or after June 9, 2008. (ii) Under the transition rule, Organization M is a publicly supported organization de-scribed in section 509(a)(2) for the taxable years ending June 30, 2004, through June 30, 2008. Organization M does not need to estab-lish within 90 days after June 30, 2008, that it met a public support test under 1.170A9(e) or 1.509(a)3, as in effect prior to September 9, 2008, (as contained in 26 CFR part 1 revised April 1, 2008) for its advance ruling period. (iii) Organization M can qualify as a public charity beginning with the taxable year end-ing June 30, 2009, if Organization M can meet the requirements of 1.170A9(f)(2) or 1.170A9(f)(3) or paragraphs (a)(2) and (a)(3) of this section for the taxable years ending June 30, 2005, through June 30, 2009, or for the taxable years ending June 30, 2004, through June 30, 2008. In addition, for its taxable year ending June 30, 2009, Organization M may qualify as a publicly supported organization by availing itself of the transition rule con-tained in paragraph (n)(iii) of this section, which looks to support received by M in the taxable years ending June 30, 2004, through June 30, 2007. Example 2. (i) Organization N was formed in January 2000 and uses a December 31 taxable year. Organization N received a final deter-mination that it was recognized as tax-ex-empt under section 501(c)(3) and as a public charity prior to September 9, 2008. (ii) For taxable year 2008, Organization N will qualify as publicly supported if it meets the requirements under either 1.170A9(f)(2) or 1.170A9(f)(3) or paragraphs (a)(2) and (a)(3) of this section for the five-year period January 1, 2004, through December 31, 2008. Organization N will also qualify as publicly supported for taxable year 2008 if it meets the requirements under either 1.170A9(e)(2) or 1.170A9(e)(3) or 1.509(a)3(a)(2) and 1.509(a)3(a)(3) as in effect prior to September 9, 2008, (as contained in 26 CFR part 1 revised April 1, 2008) for taxable year 2007, using the four-year period from January 1, 2003, through December 31, 2006. (o) Effective/applicability date. This section shall generally apply to taxable years beginning after December 31, 1969 except paragraphs (a)(2), (a)(3)(i), (c), (d), (e), (k) and (n) of this section shall apply to tax years beginning on or after January 1, 2008. For tax years be-ginning after December 31, 1969 and be-ginning before January 1, 2008, 1.509(a)3(a)(2), 1.509(a)3(a)(3)(i), 1.509(a)3(c), 1.509(a)3(d), 1.509(a)3(e), and 1.509(a)3(k) as in effect on Decem-ber 31, 2007 (as contained in 26 CFR part 1 revised April 1, 2008) shall apply. [T.D. 7212, 37 FR 21907, Oct. 17, 1972, as amended by T.D. 7784, 46 FR 37889, July 23, 1981; T.D. 8423, 57 FR 33443, July 29, 1992; T.D. 8991, 67 FR 20437, Apr. 25, 2002; T.D. 9423, 73 FR 52549, Sept. 9, 2008; T.D. 9549, 76 FR 55764, Sept. 8, 2011; T.D. 9549, 76 FR 61946, Oct. 6, 2011] 1.509(a)4 Supporting organizations. (a) In general. (1) Section 509(a)(3) ex-cludes from the definition of private foundation those organizations which meet the requirements of subpara-graphs (A), (B), and (C) thereof. (2) Section 509(a)(3)(A) provides that a section 509(a)(3) organization must be organized, and at all times thereafter operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more speci-fied organizations described in section 509(a) (1) or (2). Section 509(a)(3)(A) de-scribes the nature of the support or benefit which a section 509(a)(3) organi-zation must provide to one or more sec-tion 509(a) (1) or (2) organizations. For purposes of section 509(a)(3)(A), para-graph (b) of this section generally de-scribes the organizational and oper-ational tests; paragraph (c) of this sec-tion describes permissible purposes under the organizational test; para-graph (d) of this section describes the requirement of supporting or bene-fiting one or more specified publicly supported organizations; and paragraph (e) of this section describes permissible beneficiaries and activities under the operational test. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00132 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150123 Internal Revenue Service, Treasury 1.509(a)4 (3) Section 509(a)(3)(B) provides that a section 509(a)(3) organization must be operated, supervised, or controlled by or in connection with one or more or-ganizations described in section 509(a) (1) or (2). Section 509(a)(3)(B) and para-graph (f) of this section describe the nature of the relationship which must exist between the section 509(a)(3) and section 509(a) (1) or (2) organizations. For purposes of section 509(a)(3)(B), paragraph (g) of this section defines op-erated, supervised, or controlled by; para-graph (h) of this section defines super-vised or controlled in connection with; and paragraph (i) of this section defines operated in connection with. (4) Section 509(a)(3)(C) provides that a section 509(a)(3) organization must not be controlled directly or indirectly by disqualified persons (other than foundation managers or organizations described in section 509(a) (1) or (2)). Section 509(a)(3)(C) and paragraph (j) of this section prescribe a limitation on the control over the section 509(a)(3) organization. (5) For purposes of this section, the term supporting organization means ei-ther an organization described in sec-tion 509(a)(3) or an organization seek-ing section 509(a)(3) status, depending upon its context. For purposes of this section, the term publicly supported or-ganization means an organization de-scribed in section 509(a) (1) or (2). (6) For purposes of paragraph (i) of this section, the term supported orga-nization means a specified publicly supported organization described in paragraphs (d)(2)(iv) or (d)(4) of this section. (b) Organizational and operational tests. (1) Under subparagraph (A) of sec-tion 509(a)(3), in order to qualify as a supporting organization, an organiza-tion must be both organized and oper-ated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of (hereinafter referred to in this section as being organized and operated to support or benefit) one or more specified publicly supported orga-nizations. If an organization fails to meet either the organizational or the operational test, it cannot qualify as a supporting organization. (2) In the case of supporting organiza-tions created prior to January 1, 1970, the organizational and operational tests shall apply as of January 1, 1970. Therefore, even though the original ar-ticles of organization did not limit its purposes to those required under sec-tion 509(a)(3)(A) and even though it op-erated before January 1, 1970, for some purpose other than those required under section 509(a)(3)(A), an organiza-tion will satisfy the organizational and operational tests if, on January 1, 1970, and at all times thereafter, it is so con-stituted as to comply with these tests. For the special rules pertaining to the application of the organizational and operational tests to organizations ter-minating their private foundation sta-tus under the 12-month or 60-month termination period provided under sec-tion 507(b)(1)(B) by becoming public under section 509(a)(3), see the regula-tions under section 507(b). (c) Organizational test(1) In general. An organization is organized exclu-sively for one or more of the purposes specified in section 509(a)(3)(A) only if its articles of organization (as defined in 1.501(c)(3)1(b)(2)): (i) Limit the purposes of such organi-zation to one or more of the purposes set forth in section 509(a)(3)(A); (ii) Do not expressly empower the or-ganization to engage in activities which are not in furtherance of the purposes referred to in subdivision (i) of this subparagraph; (iii) State the specified publicly sup-ported organizations on whose behalf such organization is to be operated (within the meaning of paragraph (d) of this section); and (iv) Do not expressly empower the or-ganization to operate to support or benefit any organization other than the specified publicly supported organi-zations referred to in subdivision (iii) of this subparagraph. (2) Purposes. In meeting the organiza-tional test, the organizations pur-poses, as stated in its articles, may be as broad as, or more specific than, the purposes set forth in section 509(a)(3)(A). Therefore, an organization which, by the terms of its articles, is formed for the benefit of one or more specified publicly supported organiza-tions shall, if it otherwise meets the other requirements of this paragraph, VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00133 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150124 26 CFR Ch. I (4113 Edition) 1.509(a)4 be considered to have met the organi-zational test. Similarly, articles which state that an organization is formed to perform the publishing functions of a specified university are sufficient to comply with the organizational test. An organization which is operated, su-pervised, or controlled by (within the meaning of paragraph (g) of this sec-tion) or supervised or controlled in con-nection with (within the meaning of paragraph (h) of this section) one or more sections 509(a) (1) or (2) organiza-tions to carry out the purposes of such organizations, will be considered as meeting the requirements of this para-graph if the purposes set forth in its ar-ticles are similar to, but no broader than, the purposes set forth in the arti-cles of its controlling section 509(a) (1) or (2) organizations. If, however, the organization by which it is operated, supervised, or controlled is a publicly supported section 501(c) (4), (5), or (6) organization (deemed to be a section 509(a)(2) organization for purposes of section 509(a)(3) under the provisions of section 509(a)), the supporting organi-zation will be considered as meeting the requirements of this paragraph if its articles require it to carry on chari-table, etc., activities within the mean-ing of section 170(c)(2). (3) Limitations. An organization is not organized exclusively for the purposes set forth in section 509(a)(3)(A) if its ar-ticles expressly permit it to operate to support or benefit any organization other than those specified publicly sup-ported organizations referred to in sub-paragraph (1)(iii) of this paragraph. Thus, for example, an organization will not meet the organizational test under section 509(a)(3)(A) if its articles ex-pressly empower it to pay over any part of its income to, or perform any service for, any organization other than those publicly supported organi-zations specified in its articles (within the meaning of paragraph (d) of this section). The fact that the actual oper-ations of such organization have been exclusively for the benefit of the speci-fied publicly supported organizations shall not be sufficient to permit it to meet the organizational test. (d) Specified organizations(1) In gen-eral. In order to meet the requirements of section 509(a)(3)(A), an organization must be organized and operated exclu-sively to support or benefit one or more specified publicly supported orga-nizations. The manner in which the publicly supported organizations must be specified in the articles for purposes of section 509(a)(3)(A) will depend upon whether the supporting organization is operated, supervised, or controlled by or supervised or controlled in connection with (within the meaning of paragraphs (g) and (h) of this section) such organi-zations or whether it is operated in con-nection with (within the meaning of paragraph (i) of this section) such orga-nizations. (2) Nondesignated publicly supported organizations; requirements. (i) Except as provided in subdivision (iv) of this sub-paragraph, in order to meet the re-quirements of subparagraph (1) of this paragraph, the articles of the sup-porting organization must designate each of the specified organizations by name unless: (a) The supporting organization is op-erated, supervised, or controlled by (within the meaning of paragraph (g) of this section), or is supervised or con-trolled in connection with (within the meaning of paragraph (h) of this sec-tion) one or more publicly supported organizations; and (b) The articles of organization of the supporting organization require that it be operated to support or benefit one or more beneficiary organizations which are designated by class or purpose and which include: (1) The publicly supported organiza-tions referred to in (a) of this subdivi-sion (without designating such organi-zations by name); or (2) Publicly supported organizations which are closely related in purpose or function to those publicly supported organizations referred to in subdivision (i)(a) or this subparagraph (without designating such organization by name). (ii) If a supporting organization is de-scribed in subdivision (i)(a) of this sub-paragraph, it will not be considered as failing to meet the requirements of subparagraph (1) of this paragraph that the publicly supported organizations be specified merely because its articles of organization permit the conditions de-scribed in subparagraphs (3) (i), (ii), VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00134 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150125 Internal Revenue Service, Treasury 1.509(a)4 and (iii) and (4)(i) (a) and (b) of this paragraph. (iii) This subparagraph may be illus-trated by the following examples: Example 1. X is an organization described in section 501(c)(3) which operates for the benefit of institutions of higher learning in the State of Y. X is controlled by these insti-tutions (within the meaning of paragraph (g) of this section) and such institutions are all section 509(a)(1) organizations. Xs articles will meet the organizational test if they re-quire X to operate for the benefit of institu-tions of higher learning or educational orga-nizations in the State of Y (without naming each institution). Xs articles would also meet the organizational test if they provided for the giving of scholarships to enable stu-dents to attend institutions of higher learn-ing but only in the State of Y. Example 2. M is an organization described in section 501(c)(3) which was organized and operated by representatives of N church to run a home for the aged. M is controlled (within the meaning of paragraph (g) of this section) by N church, a section 509(a)(1) orga-nization. The care of the sick and the aged are longstanding temporal functions and purposes of organized religion. By operating a home for the aged, M is operating to sup-port or benefit N church in carrying out one of its temporal purposes. Thus Ms articles will meet the organizational test if they re-quire M to care for the aged since M is oper-ating to support one of N churchs purposes (without designating N church by name). (iv) A supporting organization will meet the requirements of subparagraph (1) of this paragraph even though its articles do not designate each of the specified organizations by name if: (a) There has been an historic and continuing relationship between the supporting organization and the sec-tion 509(a) (1) or (2) organizations, and (b) By reason of such relationship, there has developed a substantial iden-tity of interests between such organi-zations. (3) Nondesignated publicly supported organizations; scope of rule. If the re-quirements of subparagraph (2)(i) (a) of this paragraph are met, a supporting organization will not be considered as failing the test of being organized for the benefit of specified organizations solely because its articles: (i) Permit the substitution of one publicly supported organization within a designated class for another publicly supported organization either in the same or a different class designated in the articles; (ii) Permit the supporting organiza-tion to operate for the benefit of new or additional publicly supported orga-nizations of the same or a different class designated in the articles; or (iii) Permit the supporting organiza-tion to vary the amount of its support among different publicly supported or-ganizations within the class or classes of organizations designated by the arti-cles For example, X is an organization which operates for the benefit of pri-vate colleges in the State of Y. If X is controlled by these colleges (within the meaning of paragraph (g) of this sec-tion) and such colleges are all section 509(a)(1) organizations, Xs articles will meet the organization test even if they permit X to operate for the benefit of any new colleges created in State Y in addition to the existing colleges or in lieu of one which has ceased to operate, or if they permit X to vary its support by paying more to one college than to another in a particular year. (4) Designated publicly supported orga-nizations. (i) If an organization is orga-nized and operated to support one or more publicly supported organizations and it is operated in connection with such organization or organizations, then, except as provided in subpara-graph (2)(iv) of this paragraph, its arti-cles of organization must, for purposes of satisfying the organizational test under section 509(a)(3)(A), designate the specified organizations by name. Under the circumstances described in this subparagraph, a supporting organi-zation which has one or more specified organizations designated by name in its articles, will not be considered as failing the test of being organized for the benefit of specified organizations solely because its articles: (a) Permit a publicly supported orga-nization which is designated by class or purpose, rather than by name, to be substituted for the publicly supported organization or organizations des-ignated by name in the articles, but only if such substitution is conditioned upon the occurrence of an event which is beyond the control of the supporting VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00135 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150126 26 CFR Ch. I (4113 Edition) 1.509(a)4 organization, such as loss of exemp-tion, substantial failure or abandon-ment of operations, or dissolution of the publicly supported organization or organizations designated in the arti-cles; (b) Permit the supporting organiza-tion to operate for the benefit of a ben-eficiary organization which is not a publicly supported organization, but only if such supporting organization is currently operating for the benefit of a publicly supported organization and the possibility of its operating for the benefit of other than a publicly sup-ported organization is a remote contin-gency; or (c) Permit the supporting organiza-tion to vary the amount of its support between different designated organiza-tions, so long as it meets the require-ments of the integral part test set forth in paragraph (i)(3) of this section with respect to at least one beneficiary organization. (ii) If the beneficiary organization re-ferred to in subdivision (i)(b) of this subparagraph is not a publicly sup-ported organization, the supporting or-ganization will not then meet the oper-ational test of paragraph (e)(1) of this section. Therefore, if a supporting or-ganization substituted in accordance with such subdivision (i)(b) a bene-ficiary other than a publicly supported organization and operated in support of such beneficiary organization, the sup-porting organization would not be de-scribed in section 509(a)(3). (iii) This subparagraph may be illus-trated by the following example: Example. X is a charitable trust described in section 4947(a)(1) organized in 1968. Under the terms of its trust instrument, Xs trust-ees are required to pay over all of Xs annual income to M University Medical School for urological research. If M University Medical School is unable or unwilling to devote these funds to urological research, the trustees are required to pay all of such income to N Uni-versity Medical School. However if N Univer-sity Medical School is also unable or unwill-ing to devote these funds to urological re-search, Xs trustees are directed to choose a similar organization willing to apply Xs funds for urological research. From 1968 to 1973, X pays all of its net income to M Uni-versity Medical School pursuant to the terms of the trust. M and N are publicly sup-ported organizations. Although the contin-gent remainderman may not be a publicly supported organization, the possibility that X may operate for the benefit of other than a publicly supported organization is, in 1973, a remote possibility, and X will be consid-ered as operating for the benefit of a specified publicly supported organization under sub-division (i)(b) of this subparagraph. However, if, at some future date, X actually sub-stituted a nonpublicly supported organiza-tion as beneficiary, X would fail the require-ments of the operational test set forth in paragraph (e)(1) of this section. (e) Operational test(1) Permissible beneficiaries. A supporting organization will be regarded as operated exclusively to support one or more specified pub-licly supported organizations (herein-after referred to as the operational test) only if it engages solely in activities which support or benefit the specified publicly supported organizations. Such activities may include making pay-ments to or for the use of, or providing services or facilities for, individual members of the charitable class bene-fited by the specified publicly sup-ported organization. A supporting or-ganization may also, for example, make a payment indirectly through an-other unrelated organization to a mem-ber of a charitable class benefited by the specified publicly supported organi-zation, but only if such a payment con-stitutes a grant to an individual rather than a grant to an organization. In de-termining whether a grant is indirectly to an individual rather than to an or-ganization the same standard shall be applied as in 53.49454(a)(4) of this chapter. Similarly, an organization will be regarded as operated exclusively to support or benefit one or more speci-fied publicly supported organizations even if it supports or benefits an orga-nization, other than a private founda-tion, which is described in section 501(c)(3) and is operated, supervised, or controlled directly by or in connection with such publicly supported organiza-tions, or which is described in section 511(a)(2)(B). However, an organization will not be regarded as operated exclu-sively if any part of its activities is in furtherance of a purpose other than supporting or benefiting one or more specified publicly supported organiza-tions. (2) Permissible activities. A supporting organization is not required to pay VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00136 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150127 Internal Revenue Service, Treasury 1.509(a)4 over its income to the publicly sup-ported organizations in order to meet the operational test. It may satisfy the test by using its income to carry on an independent activity or program which supports or benefits the specified pub-licly supported organizations. All such support must, however, be limited to permissible beneficiaries in accordance with subparagraph (1) of this para-graph. The supporting organization may also engage in fund raising activi-ties, such as solicitations, fund raising dinners, and unrelated trade or busi-ness to raise funds for the publicly sup-ported organizations, or for the permis-sible beneficiaries. (3) Examples. The provisions of this paragraph may be illustrated by the following examples: Example 1. M is a separately incorporated alumni association of X University and is an organization described in section 501(c)(3). X University is designated in Ms articles as the sole beneficiary of its support. M uses all of its dues and income to support its own program of educational activities for alumni, faculty, and students of X University and to encourage alumni to maintain a close rela-tionship with the university and to make contributions to it. M does not distribute any of its income directly to X for the latters general purposes. M pays no part of its funds to, or for the benefit of, any organi-zation other than X. Under these cir-cumstances, M is considered as operated ex-clusively to perform the functions and carry out the purpose of X. Although it does not pay over any of its funds to X, it carries on a program which both supports and benefits X. Example 2. N is a separately incorporated religious and educational organization de-scribed in section 501(c)(3). It was formed and is operated by Y Church to provide religious training for the members of the church. While it does not maintain a regular faculty, N conducts a Sunday school, weekly adult education lectures on religious subjects, and other similar activities for the benefit of the church members. All of its funds are dis-bursed in furtherance of such activities and no part of its funds is paid to, or for the ben-efit of, any organization other than Y Church. N is considered as operated exclu-sively to perform the educational functions of Y Church and to carry out its religious purposes by providing various forms of reli-gious instruction. Example 3. P is an organization described in section 501(c)(3). Its primary activity is pro-viding financial assistance to S, a publicly supported organization which aids under-developed nations in Central America. Ps articles of organization designate S as the principal recipient of Ps assistance. How-ever, P also makes a small annual general purpose grant to T, a private foundation en-gaged in work similar to that carried on by S. T performs a particular function that as-sists in the overall aid program carried on by S. Even though P is operating primarily for the benefit of S, a specified publicly sup-ported organization, it is not considered as operated exclusively for the purposes set forth in section 509(a)(3)(A). The grant to T, a private foundation, prevents it from com-plying with the operational test under sec-tion 509(a)(3)(A). Example 4. Assume the same facts as exam-ple 3, except that T is a section 501(c)(3) or-ganization other than a private foundation and is operated in connection with S. Under these circumstances, P will be considered as operated exclusively to support S within the meaning of section 509(a)(3)(A). Example 5. Assume the same facts as exam-ple 3 except that instead of the annual gen-eral purpose grant made to T, each grant made by P to T is specifically earmarked for the training of social workers and teachers, designated by name, from Central America. Under these circumstances, Ps grants to T would be treated as grants to the individual social workers and teachers under section 4945(d)(3) and 53.49454(a)(4), rather than as grants to T under section 4945(d)(4). These social workers and teachers are part of the charitable class benefitted by S. P would thus be considered as operating exclusively to support S within the meaning of section 509(a)(3)(A). (f) Nature of relationship required be-tween organizations(1) In general. Sec-tion 509(a)(3)(B) describes the nature of the relationship required between a section 501(c)(3) organization and one or more publicly supported organiza-tions in order for such section 501(c)(3) organization to qualify under the pro-visions of section 509(a)(3). To meet the requirements of section 509(a)(3), an or-ganization must be operated, super-vised, or controlled by or in connection with one or more publicly supported organizations. If an organization does not stand in one of such relationships (as provided in this paragraph) to one or more publicly supported organiza-tions, it is not an organization de-scribed in section 509(a)(3). (2) Types of relationships. Section 509(a)(3)(B) sets forth three different types of relationships, one of which must be met in order to meet the re-quirements of subparagraph (1) of this VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00137 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150128 26 CFR Ch. I (4113 Edition) 1.509(a)4 paragraph. Thus, a supporting organi-zation may be: (i) Operated, supervised, or con-trolled by, (ii) Supervised or controlled in con-nection with, or (iii) Operated in connection with, one or more publicly supported organiza-tions. (3) Requirements of relationships. Al-though more than one type of relation-ship may exist in any one case, any re-lationship described in section 509(a)(3)(B) must insure that: (i) The supporting organization will be responsive to the needs of demands of one or more publicly supported orga-nizations; and (ii) The supporting organization will constitute an integral part of, or main-tain a significant involvement in, the operations of one or more publicly sup-ported organizations. (4) General description of relationships. In the case of supporting organizations which are operated, supervised, or con-trolled by one or more publicly sup-ported organizations, the distin-guishing feature of this type of rela-tionship is the presence of a substan-tial degree of direction by the publicly supported organizations over the con-duct of the supporting organization, as described in paragraph (g) of this sec-tion. In the case of supporting organi-zations which are supervised or con-trolled in connection with one or more publicly supported organizations, the distinguishing feature is the presence of common supervision or control among the governing bodies of all orga-nizations involved, such as the pres-ence of common directors, as described in paragraph (h) of this section. In the case of a supporting organization which is operated in connection with one or more publicly supported organiza-tions, the distinguishing feature is that the supporting organization is respon-sive to, and significantly involved in the operations of, the publicly sup-ported organization, as described in paragraph (i) of this section. (5) Contributions from controlling do-nors(i) In general. For any taxable year, a supporting organization shall not be considered to be operated, super-vised, or controlled by, or operated in connection with, one or more publicly supported organizations, if the sup-porting organization accepts any gift or contribution from any person who is (A) A person (other than an organiza-tion described in section 509(a)(1), (2), or (4)) who directly or indirectly con-trols, either alone or together with per-sons described in paragraphs (f)(5)(i)(B) or (f)(5)(i)(C) of this section, the gov-erning body of a specified publicly sup-ported organization supported by such supporting organization; (B) A member of the family (deter-mined under section 4958(f)(4)) of an in-dividual described in paragraph (f)(5)(i)(A) of this section; or (C) A 35-percent controlled entity (as defined in section 4958(f)(3) by sub-stituting clause (i) or (ii) of section 509(f)(2)(B) for subparagraph (A) or (B) of paragraph (1) in paragraph (f)(3)(A)(i) thereof). (ii) Meaning of control. [Reserved] (g) Meaning of operated, supervised, or controlled by. (1)(i) Each of the items operated by, supervised by, and controlled by, as used in section 509(a)(3)(B), pre-supposes a substantial degree of direc-tion over the policies, programs, and activities of a supporting organization by one or more publicly supported or-ganizations. The relationship required under any one of these terms is com-parable to that of a parent and sub-sidiary, where the subsidiary is under the direction of, and accountable or re-sponsible to, the parent organization. This relationship is established by the fact that a majority of the officers, di-rectors, or trustees of the supporting organization are appointed or elected by the governing body, members of the governing body, officers acting in their official capacity, or the membership of one or more publicly supported organi-zations. (ii) A supporting organization may be operated, supervised, or controlled by one or more publicly supported organiza-tions within the meaning of section 509(a)(3)(B) even though its governing body is not comprised of representa-tives of the specified publicly sup-ported organizations for whose benefit it is operated within the meaning of section 509(a)(3)(A). A supporting orga-nization may be operated, supervised, or VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00138 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150129 Internal Revenue Service, Treasury 1.509(a)4 controlled by one or more publicly sup-ported organizations (within the mean-ing of section 509(a)(3)(B)) and be oper-ated for the benefit of one or more dif-ferent publicly supported organizations (within the meaning of section 509(a)(3)(A)) only if it can be dem-onstrated that the purposes of the former organizations are carried out by benefitting the latter organizations. (2) The provisions of this paragraph may be illustrated by the following ex-amples: Example 1. X is a university press which is organized and operated as a nonstock edu-cational corporation to perform the pub-lishing and printing for M University, a pub-licly supported organization. Control of X is vested in a Board of Governors appointed by the Board of Trustees of M University upon the recommendation of the president of the university. X is considered to be operated, supervised, or controlled by M University within the meaning of section 509(a)(3)(B). Example 2. Y Council was organized under the joint sponsorship of seven independent publicly supported organizations, each of which is dedicated to the advancement of knowledge in a particular field of social science. The sponsoring organizations orga-nized Y Council as a means of pooling their ideas and resources for the attainment of common objectives, including the con-ducting of scholarly studies and formal dis-cussions in various fields of social science. Under Y Councils by-laws, each of the seven sponsoring organizations elects three mem-bers to Ys board of trustees for 3-year terms. Ys board also includes the president of Y Council and eight other individuals elected at large by the board. Pursuant to policies established or approved by the board, Y Council engages in research, planning, and evaluation in the social sciences and spon-sors or arranges conferences, seminars, and similar programs for scholars and social sci-entists. It carries out these activities through its own full-time professional staff, through a part-time committee of scholars, and through grant recipients. Under the above circumstances, Y Council is subject to a substantial degree of direction by the spon-soring publicly supported organizations. It is therefore considered to be operated, super-vised, or controlled by such sponsoring orga-nizations within the meaning of section 509(a)(3)(B). Example 3. Z is a charitable trust created by A in 1972. It has three trustees, all of whom are appointed by M University, a pub-licly supported organization. The trust was organized and is operated to pay over all of its net income for medical research to N, O, and P, each of which is specified in the trust, is a hospital described in section 509(a)(1), and is located in the same city as M. Mem-bers of Ms biology department are permitted to use the research facilities of N, O, and P. Under subparagraph (1)(ii) of this paragraph, Z is considered to be operated, supervised, or controlled by M within the meaning of sec-tion 509(a)(3)(B), even though it is operated for the benefit of N, O, and P within the meaning of section 509(a)(3)(A). (h) Meaning of supervised or controlled in connection with. (1) In order for a supporting organization to be super-vised or controlled in connection with one or more publicly supported organiza-tions, there must be common super-vision or control by the persons super-vising or controlling both the sup-porting organization and the publicly supported organizations to insure that the supporting organization will be re-sponsive to the needs and requirements of the publicly supported organiza-tions. Therefore, in order to meet such requirement, the control or manage-ment of the supporting organization must be vested in the same persons that control or manage the publicly supported organizations. (2) A supporting organization will not be considered to be supervised or con-trolled in connection with one or more publicly supported organizations if such organization merely makes pay-ments (mandatory or discretionary) to one or more named publicly supported organizations, even if the obligation to make payments to the named bene-ficiaries is enforceable under State law by such beneficiaries and the sup-porting organizations governing in-strument contains provisions whose ef-fect is described in section 508(e)(1) (A) and (B). Such arrangements do not pro-vide a sufficient connection between the payor organization and the needs and requirements of the publicly supported organizations to constitute supervision or control in connection with such or-ganizations. (3) The provisions of this paragraph may be illustrated by the following ex-amples: Example 1. A, a philanthropist, founded X school for orphan boys (a publicly supported organization). At the same time A founded X school, he also established Y trust into which he transferred all of the operating as-sets of the school, together with a substan-tial endowment for it. Under the provisions VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00139 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150130 26 CFR Ch. I (4113 Edition) 1.509(a)4 of the trust instrument, the same persons who control and manage the school also con-trol and manage the trust. The sole function of Y trust is to hold legal title to X schools operating and endowment assets, to invest the endowment assets and to apply the in-come from the endowment to the benefit of the school in accordance with direction from the schools governing body. Under these cir-cumstances, Y trust is organized and oper-ated for the benefit of X school and is super-vised or controlled in connection with such or-ganization within the meaning of section 509(a)(3). The fact that the same persons con-trol both X and Y insures Ys responsiveness to Xs needs. Example 2. In 1972, B, a philanthropist, cre-ated P, a charitable trust for the benefit of Z, a symphony orchestra described in section 509(a)(2). B transferred 100 shares of common stock to P. Under the terms of the trust in-strument, the trustees (none of whom is under the control of B) were required to pay over all of the income produced by the trust assets to Z. The governing instrument of P contains certain provisions whose effect is described in section 508(e)(1) (A) and (B). Under applicable State law, Z can enforce the provisions of the trust instrument and compel payment to Z in a court of equity. There is no relationship between the trustees of P and the governing body of Z. Under these circumstances P is not supervised or controlled in connection with a publicly sup-ported organization. Because of the lack of any common supervision or control by the trustees of P and the governing body of Z, P is not supervised or controlled in connection with Z within the meaning of section 509(a)(3)(B). Example 3. T is a charitable trust described in section 501(c)(3) and created under the will of D. Prior to his death, D was a leader and very active in C church, a publicly supported organization. D created T to perpetuate his interest in, and assistance to, C. The sole purpose of T was to provide financial support for C and its related institutions. All of the original named trustees of T are members of C, are leaders in C, and hold important of-fices in one or more of Cs related institu-tions. Successor trustees of T are by the terms of the charitable trust instrument to be chosen by the remaining trustees and are also to be members of C. All of the original trustees have represented that any successor trustee will be a leader in C and will hold an important office in one or more of Cs related institutions. By reason of the foregoing rela-tionship T and its trustees are responsive to the needs and requirements of C and its re-lated institutions. Under these cir-cumstances, T trust is organized and oper-ated for the benefit of C and is supervised or controlled in connection with C and its related institutions within the meaning of section 509(a)(3)(B). (i) Meaning of operated in connection with(1) General rule. For each taxable year, a supporting organization is oper-ated in connection with one or more supported organizations (that is, is a Type III supporting organization) only if it is not disqualified by reason of paragraph (f)(5) (relating to accept-ance of contributions from controlling donors) or paragraph (i)(10) (relating to foreign supported organizations) of this section, and it satisfies (i) The notification requirement, which is set forth in paragraph (i)(2) of this section; (ii) The responsiveness test, which is set forth in paragraph (i)(3) of this sec-tion; and (iii) The integral part test, which is satisfied by maintaining significant in-volvement in the operations of one or more supported organizations and pro-viding support on which the supported organization(s) are dependent; in order to satisfy this test, the supporting or-ganization must meet the requirements either for (A) Functionally integrated Type III supporting organizations set forth in paragraph (i)(4) of this section; or (B) Non-functionally integrated Type III supporting organizations set forth in paragraph (i)(5) of this section. (2) Notification requirement(i) Annual notification. For each taxable year, a Type III supporting organization must provide the following documents to each of its supported organizations: (A) A written notice addressed to a principal officer of the supported orga-nization describing the type and amount of all of the support the sup-porting organization provided to the supported organization during the sup-porting organizations taxable year im-mediately preceding the taxable year in which the written notice is provided (and during any other taxable year of the supporting organization ending after December 28, 2012, for which such support information has not previously been provided); (B) A copy of the supporting organi-zations Form 990, Return of Organiza-tion Exempt from Income Tax, or other annual information return re-quired to be filed under section 6033 (al-though the supporting organization may redact from the return the name VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00140 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150131 Internal Revenue Service, Treasury 1.509(a)4 and address of any contributor to the organization) that was most recently filed as of the date the notification is provided (and any such return for any other taxable year of the supporting organization ending after December 28, 2012, that has not previously been pro-vided to the supported organization); and (C) A copy of the supporting organi-zations governing documents as in ef-fect on the date the notification is pro-vided, including its articles of organi-zation and bylaws (if any) and any amendments to such documents, unless such documents have been previously provided and not subsequently amend-ed. (ii) Electronic media. The notification documents required by this paragraph (i)(2) may be provided by electronic media. (iii) Due date. The notification docu-ments required by this paragraph (i)(2) for any taxable year shall be post-marked or electronically transmitted by the last day of the fifth calendar month following the close of that tax-able year. (iv) Principal officer. For purposes of paragraph (i)(2)(i)(A) of this section, a principal officer includes, but is not limited to, a person who, regardless of title, has ultimate responsibility for (A) Implementing the decisions of the governing body of a supported or-ganization; (B) Supervising the management, ad-ministration, or operation of the sup-ported organization; or (C) Managing the finances of the sup-ported organization. (3) Responsiveness test(i) General rule. A supporting organization meets the responsiveness test if it is respon-sive to the needs or demands of a sup-ported organization. Except as pro-vided in paragraph (i)(3)(v) of this sec-tion, in order to meet this test, a sup-porting organization must satisfy the requirements of paragraphs (i)(3)(ii) and (i)(3)(iii) of this section. (ii) Relationship of officers, directors, or trustees. A supporting organization sat-isfies the requirements of this para-graph (i)(3)(ii) with respect to a sup-ported organization only if (A) One or more officers, directors, or trustees of the supporting organization are elected or appointed by the offi-cers, directors, trustees, or member-ship of the supported organization; (B) One or more members of the gov-erning body of the supported organiza-tion are also officers, directors, or trustees of, or hold other important of-fices in, the supporting organization; or (C) The officers, directors, or trustees of the supporting organization main-tain a close and continuous working re-lationship with the officers, directors, or trustees of the supported organiza-tion. (iii) Significant voice. A supporting or-ganization satisfies the requirements of this paragraph (i)(3)(iii) only if, by reason of paragraphs (i)(3)(ii)(A), (i)(3)(ii)(B), or (i)(3)(ii)(C) of this sec-tion, the officers, directors, or trustees of the supported organization have a significant voice in the investment policies of the supporting organization, the timing of grants, the manner of making grants, and the selection of grant recipients by such supporting or-ganization, and in otherwise directing the use of the income or assets of the supporting organization. (iv) Examples. The provisions of this paragraph (i)(3) may be illustrated by the following examples: Example 1. X, an organization described in section 501(c)(3), is a trust created under the last will and testament of Decedent. The trustee of X (Trustee) is a bank. Under the trust instrument, X supports M, a private university described in section 509(a)(1). The trust instrument provides that Trustee has discretion regarding the timing and amount of distributions consistent with the Trust-ees fiduciary duties. Representatives of Trustee and an officer of M have quarterly face-to-face or telephonic meetings during which they discuss Ms projected needs and ways in which M would like X to use its in-come and invest its assets. Additionally, Trustee communicates regularly with that officer of M regarding Xs investments and plans for distributions from X. Trustee pro-vides the officer of M with quarterly invest-ment statements, the information required under paragraph (i)(2) of this section, and an annual accounting statement. Based on these facts, X meets the responsiveness test of this paragraph (i)(3) with respect to M. Example 2. Y is an organization described in section 501(c)(3) and is a trust under State law. The trustee of Y (Trustee) is a bank. Y supports charities P, Q, and R, each an orga-nization described in section 509(a)(1). Y VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00141 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150132 26 CFR Ch. I (4113 Edition) 1.509(a)4 makes annual cash payments to P, Q, and R. Once a year, Trustee sends to P, Q, and R the cash payment, the information required under paragraph (i)(2) of this section, and an accounting statement. Trustee has no other communication with P, Q, or R. Y does not meet the responsiveness test of this para-graph (i)(3). (v) Exception for pre-November 20, 1970 organizations. In the case of a sup-porting organization that was sup-porting or benefiting a supported orga-nization before November 20, 1970, addi-tional facts and circumstances, such as a historic and continuing relationship between the organizations, may be taken into account, in addition to the factors described in paragraphs (i)(3)(ii) and (i)(3)(iii) of this section, to estab-lish compliance with the responsive-ness test. (4) Integral part testfunctionally inte-grated Type III supporting organization (i) General rule. A supporting organiza-tion meets the integral part test and will be considered functionally inte-grated within the meaning of section 4943(f)(5)(B), if it (A) Engages in activities substan-tially all of which directly further the exempt purposes of one or more sup-ported organizations and otherwise meets the requirements described in paragraph (i)(4)(ii) of this section; (B) Is the parent of each of its sup-ported organizations, as described in paragraph (i)(4)(iii) of this section; or (C) Supports a governmental sup-ported organization and otherwise meets the requirements of paragraph (i)(4)(iv) of this section. (ii) Substantially all activities directly further exempt purposes(A) In general. A supporting organization meets the requirements of this paragraph (i)(4)(ii) if it engages in activities substantially all of which (1) Directly further the exempt pur-poses of one or more supported organi-zations to which the supporting organi-zation is responsive by performing the functions of, or carrying out the pur-poses of, such supported organiza-tion(s); and (2) But for the involvement of the supporting organization, would nor-mally be engaged in by such supported organization(s). (B) Meaning of substantially all. For purposes of paragraph (i)(4)(ii)(A) of this section, in determining whether substantially all of a supporting orga-nizations activities directly further the exempt purposes of one or more supported organization(s) to which the supporting organization is responsive, all pertinent facts and circumstances will be taken into consideration. (C) Meaning of directly further. Activi-ties directly further the exempt pur-poses of one or more supported organi-zations for purposes of this paragraph (i)(4) only if they are conducted by the supporting organization itself, rather than by a supported organization. Holding title to and managing exempt- use assets described in 1.509(a) 4T(i)(8)(ii) are activities that directly further the exempt purposes of the sup-ported organization within the mean-ing of this paragraph (i)(4). Conversely, except as provided in paragraph (i)(4)(ii)(D) of this section, fundraising, making grants (whether to the sup-ported organization or to third par-ties), and investing and managing non- exempt-use assets are not activities that directly further the exempt pur-poses of the supported organization within the meaning of this paragraph (i)(4). (D) Payments to individual bene-ficiaries. The making or awarding of grants, scholarships, or other pay-ments to individual beneficiaries who are members of the charitable class benefited by a supported organization will be treated as an activity that di-rectly furthers the exempt purposes of that supported organization for pur-poses of this paragraph (i)(4) only if (1) The individual beneficiaries are selected on an objective and non-discriminatory basis (as described in 53.49454(b)); (2) The officers, directors, or trustees of the supported organization have a significant voice in the timing of the payments, the manner of making them, and the selection of recipients; and (3) The making or awarding of such payments is part of an active program of the supporting organization that di-rectly furthers the exempt purposes of the supported organization and in which the supporting organization maintains significant involvement, as defined in 53.4942(b)1(b)(2)(ii) (except VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00142 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150133 Internal Revenue Service, Treasury 1.509(a)4 that supporting organization shall be substituted for foundation). (iii) Parent of supported organiza-tion(s). For purposes of paragraph (i)(4)(i)(B) of this section, a supporting organization is the parent of a sup-ported organization if the supporting organization exercises a substantial de-gree of direction over the policies, pro-grams, and activities of the supported organization and a majority of the offi-cers, directors, or trustees of the sup-ported organization is appointed or elected, directly or indirectly, by the governing body, members of the gov-erning body, or officers (acting in their official capacity) of the supporting or-ganization. (iv) Supporting a governmental entity. [Reserved] (v) Examples. The provisions of this paragraph (i)(4) may be illustrated by the following examples: Example 1. N, an organization described in section 501(c)(3), is the parent organization of a healthcare system consisting of two hos-pitals (Q and R) and an outpatient clinic (S), each of which is described in section 509(a)(1), and a taxable subsidiary (T). N is the sole member of each of Q, R, and S. Under the charter and bylaws of each of Q, R, and S, N appoints all members of the board of directors of each corporation. N engages in the overall coordination and supervision of the healthcare systems exempt subsidiary corporations Q, R, and S in approval of their budgets, strategic planning, marketing, re-source allocation, securing tax-exempt bond financing, and community education. N also manages and invests assets that serve as en-dowments of Q, R, and S. Based on these facts, N qualifies as a functionally inte-grated Type III supporting organization under paragraph (i)(4)(i)(B) of this section. Example 2. V, an organization described in section 501(c)(3), is organized and operated as a supporting organization to L, a church de-scribed in section 509(a)(1). V meets the re-sponsiveness test described in paragraph (i)(3) of this section with respect to L. L transferred to V title to the buildings in which L conducts religious services, Bible study, and community enrichment programs. Substantially all of Vs activities consist of holding and maintaining these buildings, which L continues to use, free of charge, to further its exempt purposes. But for the ac-tivities of V, L would hold and maintain the buildings. Based on these facts, V satisfies the requirements of paragraph (i)(4)(ii) of this section. Example 3. O is a local nonprofit food pan-try described in section 501(c)(3). O collects donated food from local growers, grocery stores, and individuals and distributes this food free of charge to poor and needy people in Os community. O is organized and oper-ated as a supporting organization to eight churches of a particular denomination lo-cated in Os community, each of which is de-scribed in section 509(a)(1). Control of O is vested in a five-member Board of Directors, which includes an official from one of the churches as well as four lay members of the churches congregations. The officers of O maintain a close and continuing working re-lationship with each of the eight churches and as a result of such relationship, each of the eight churches has a significant voice in directing the use of the income and assets of O. As a result, O is responsive to its sup-ported organizations. All of Os activities di-rectly further the exempt purposes of the eight supported organizations to which it is responsive. Additionally, but for the activi-ties of O, the churches would normally oper-ate food pantries themselves. Based on these facts, O satisfies the requirements of para-graph (i)(4)(ii) of this section. Example 4. M, an organization described in section 501(c)(3), was created by B, an indi-vidual, to provide scholarships for students of U, a private secondary school and an orga-nization described in section 509(a)(1). U es-tablishes the scholarship criteria, publicizes the scholarship program, solicits and reviews applications, and selects the scholarship re-cipients. M invests its assets and disburses the funds for scholarships to the recipients selected by U. M does not provide the schol-arships as part of an active program in which it maintains significant involvement, as de-fined in 53.4942(b)1(b)(2)(ii). Based on these facts, M does not satisfy the requirements of paragraph (i)(4)(ii) of this section. Example 5. J, an organization described in section 501(c)(3), is organized as a supporting organization to community foundation G, an organization described in section 509(a)(1). J meets the responsiveness test described in paragraph (i)(3) of this section with respect to G. In addition to maintaining field-of-in-terest funds, sponsoring donor advised funds, and conducting general grantmaking activi-ties, G also engages in activities to beautify and maintain local parks. Substantially all of Js activities consist of maintaining all of the local parks in the area of community foundation G by performing activities such as establishing and maintaining trails, planting trees, and removing trash. But for the activities of J, G would normally engage in these efforts to beautify and maintain the local parks. Based on these facts, J satisfies the requirements of paragraph (i)(4)(ii) of this section. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00143 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150134 26 CFR Ch. I (4113 Edition) 1.509(a)4 (5) Integral part testnon-functionally integrated Type III supporting organiza-tion(i) General rule. A supporting or-ganization meets the integral part test and will be considered non-functionally integrated if it satisfies either (A) The distribution requirement of paragraph (i)(5)(ii) of this section and the attentiveness requirement of para-graph (i)(5)(iii) of this section; or (B) The pre-November 20, 1970 trust requirements of paragraph (i)(9) of this section. (ii) Distribution requirement(A) An-nual distribution. With respect to each taxable year, a supporting organization must distribute to or for the use of one or more supported organizations an amount equaling or exceeding the sup-porting organizations distributable amount for the taxable year, as defined in 1.509(a)4T(i)(5)(ii)(B), on or before the last day of the taxable year. (B) Distributable amount. [Reserved] For further guidance, see 1.509(a) 4T(i)(5)(ii)(B). (C) Minimum asset amount. [Reserved] For further guidance, see 1.509(a) 4T(i)(5)(ii)(C). (D) First taxable year. The distribut-able amount for the first taxable year an organization is treated as a non- functionally integrated Type III sup-porting organization is zero. Notwith-standing the foregoing, for purposes of determining whether an excess amount is created under paragraph (i)(7)(ii) of this section, the distributable amount for the first taxable year an organiza-tion is treated as a non-functionally in-tegrated Type III supporting organiza-tion is the distributable amount that would apply under 1.509(a) 4T(i)(5)(ii)(B) in the absence of this paragraph (i)(5)(ii)(D). (E) Emergency temporary reduction. The Secretary may provide by publica-tion in the Internal Revenue Bulletin (see 601.601(d)(2)(ii)(b) of this chapter) for a temporary reduction in the dis-tributable amount in the case of a dis-aster or emergency. (F) Reasonable cause exception. A non- functionally integrated Type III sup-porting organization that fails to meet the distribution requirement of this paragraph (i)(5)(ii) will not be classified as a private foundation for the taxable year in which it fails to meet the dis-tribution requirement if the organiza-tion establishes to the satisfaction of the Secretary that (1) The failure was due solely to un-foreseen events or circumstances that are beyond the organizations control, a clerical error, or an incorrect valu-ation of assets; (2) The failure was due to reasonable cause and not to willful neglect; and (3) The distribution requirement is met within 180 days after the organiza-tion is first able to distribute its dis-tributable amount notwithstanding the unforeseen events or circumstances, or 180 days after the date the incorrect valuation or clerical error was or should have been discovered; however, no amounts paid to meet a distribution requirement for a prior taxable year under this paragraph (i)(5)(ii)(F)(3) may be counted toward the distribution re-quirement for the taxable year in which such amounts are paid. (iii) Attentiveness requirement(A) General rule. With respect to each tax-able year, a non-functionally inte-grated Type III supporting organiza-tion must distribute one-third or more of its distributable amount to one or more supported organizations that are attentive to the operations of the sup-porting organization (within the mean-ing of paragraph (i)(5)(iii)(B) of this section) and to which the supporting organization is responsive (within the meaning of paragraph (i)(3) of this sec-tion). (B) Attentiveness. A supported organi-zation is attentive to the operations of the supporting organization during a taxable year if, in the taxable year, at least one of the following requirements is satisfied: (1) The supporting organization dis-tributes to the supported organization amounts equaling or exceeding 10 per-cent of the supported organizations total support (or, in the case of a par-ticular department or school of a uni-versity, hospital, or church, the total support of the department or school) received during the supported organiza-tions last taxable year ending before the beginning of the supporting organi-zations taxable year. (2) The amount of support received from the supporting organization is necessary to avoid the interruption of VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00144 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150135 Internal Revenue Service, Treasury 1.509(a)4 the carrying on of a particular function or activity of the supported organiza-tion. The support is necessary if the supporting organization or the sup-ported organization earmarks the sup-port for a particular program or activ-ity of the supported organization, even if such program or activity is not the supported organizations primary pro-gram or activity, as long as such pro-gram or activity is a substantial one. (3) Based on the consideration of all pertinent factors, including the num-ber of supported organizations, the length and nature of the relationship between the supported organization and supporting organization, and the purpose to which the funds are put, the amount of support received from the supporting organization is a sufficient part of a supported organizations total support (or, in the case of a particular department or school of a university, hospital, or church, the total support of the department or school) to ensure attentiveness. Normally the attentive-ness of a supported organization is in-fluenced by the amounts received from the supporting organization. Thus, the more substantial the amount involved in terms of a percentage of the sup-ported organizations total support, the greater the likelihood that the re-quired degree of attentiveness will be present. However, in determining whether the amount received from the supporting organization is sufficient to ensure the attentiveness of the sup-ported organization to the operations of the supporting organization (includ-ing attentiveness to the nature and yield of the supporting organizations investments), evidence of actual atten-tiveness by the supported organization is of almost equal importance. A sup-ported organization is not considered to be attentive solely because it has enforceable rights against the sup-porting organization under state law. (C) Distribution to donor advised fund disregarded. Notwithstanding paragraph (i)(5)(iii)(B) of this section, in deter-mining whether a supported organiza-tion will be considered attentive to the operations of a supporting organiza-tion, any amount received from the supporting organization that is held by the supported organization in a donor advised fund described in section 4966(d)(2) will be disregarded. (D) Examples. This paragraph (i)(5)(iii) is illustrated by the following examples: Example 1. K, an organization described in section 501(c)(3), annually pays an aggregate amount equaling or exceeding its distribut-able amount described in 1.509(a) 4T(i)(5)(ii)(B) to L, a museum described in section 509(a)(2). K meets the responsiveness test described in paragraph (i)(3) of this sec-tion with respect to L. In recent years, L has earmarked the income received from K to underwrite the cost of carrying on a chamber music series consisting of 12 performances a year that are performed for the general pub-lic free of charge at its premises. The cham-ber music series is not Ls primary activity but it is a substantial activity. L could not continue the performances without Ks sup-port. Based on these facts, K meets the re-quirements of paragraph (i)(5)(iii)(B)(2) of this section. Example 2. M, an organization described in section 501(c)(3), annually pays an aggregate amount equaling or exceeding its distribut-able amount described in 1.509(a) 4T(i)(5)(ii)(B) to the Law School of N Univer-sity, an organization described in section 509(a)(1). M meets the responsiveness test de-scribed in paragraph (i)(3) of this section with respect to N. M has earmarked the in-come paid over to Ns Law School to endow a chair in International Law. Without Ms continued support, N could not continue to maintain this chair. The chair is not Ns pri-mary activity but it is a substantial activ-ity. Based on these facts, M meets the re-quirements of paragraph (i)(5)(iii)(B)(2) of this section. Example 3. R is a charitable trust created under the will of B, who died in 1969. Rs pur-pose is to hold assets as an endowment for S (a hospital), T (a university), and U (a na-tional medical research organization), all or-ganizations described in section 509(a)(1) and specifically named in the trust instrument, and to distribute all of the income each year in equal shares among the three named bene-ficiaries. Each year, R pays to S, T, and U an aggregate amount equaling or exceeding its distributable amount described in 1.509(a) 4T(i)(5)(ii)(B). Such payments equal less than one percent of the total support that each supported organization received in its most recently completed taxable year. Based on these facts, R does not meet the require-ments of paragraph (i)(5)(iii)(B)(1) of this sec-tion. However, because B died prior to No-vember 20, 1970, R could meet the require-ments of paragraph (i)(5)(i)(B) of this section upon meeting all of the requirements of paragraph (i)(9) of this section. Example 4. O is an organization described in section 501(c)(3). O is organized to support VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00145 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150136 26 CFR Ch. I (4113 Edition) 1.509(a)4 five private universities, V, W, X, Y, and Z, each of which is described in section 509(a)(1). O meets the responsiveness test under paragraph (i)(3) of this section only as to V. Each year, O distributes an aggregate amount that equals its distributable amount described in 1.509(a)4T(i)(5)(ii)(B) and dis-tributes an equal amount to each of the five universities. Accordingly, O distributes only one-fifth of its distributable amount to a supported organization to which O is also re-sponsive (V). Because O does not distribute at least one-third of its distributable amount to supported organizations that are both at-tentive to the operations of O and to which the O is responsive, O does not meet the at-tentiveness requirements of this paragraph (i)(5)(iii). (6) Distributions that count toward dis-tribution requirement. For purposes of this paragraph (i)(6), the amount of a distribution made to a supported orga-nization is the amount of cash distrib-uted or the fair-market value of the property distributed as of the date the distribution is made. The amount of a distribution will be determined solely on the cash receipts and disbursements method of accounting described in sec-tion 446(c)(1). Distributions by the sup-porting organization that count toward the distribution requirement imposed in paragraph (i)(5)(ii) of this section shall include, but not be limited to (i) Any amount paid to a supported organization to accomplish the sup-ported organizations exempt purposes; (ii) Any amount paid by the sup-porting organization to perform an ac-tivity that satisfies the requirements of paragraph (i)(4)(ii) of this section, but only to the extent such amount ex-ceeds any income derived by the sup-porting organization from the activity; (iii) Any reasonable and necessary administrative expenses paid to accom-plish the exempt purposes of the sup-ported organization(s), which do not in-clude expenses incurred in the produc-tion of investment income; (iv) Any amount paid to acquire an exempt-use asset described in 1.509(a) 4T(i)(8)(ii); and (v) Any amount set aside for a spe-cific project that accomplishes the ex-empt purposes of a supported organiza-tion to which the supporting organiza-tion is responsive, with such set aside counting toward the distribution re-quirement for the taxable year in which the amount is set aside but not in the year in which it is actually paid, if at the time of the set-aside, the sup-porting organization (A) Obtains a written statement from each supported organization whose ex-empt purposes the specific project ac-complishes, signed under penalty of perjury by one of the supported organi-zations principal officers, as defined in paragraph (i)(2)(iv) of this section, stating that the supported organiza-tion approves the project as one that accomplishes one or more of the sup-ported organizations exempt purposes and also approves the supporting orga-nizations determination that the project is one that can be better ac-complished by such a set-aside than by the immediate payment of funds; (B) Establishes to the satisfaction of the Commissioner, by meeting the ap-proval and information requirements described in 53.4942(a)3(b)(7)(i) of this chapter and by providing the written statement described in paragraph (i)(6)(v)(A) of this section, that the amount set aside will be paid for the specific project within 60 months after it is set aside and that the project is one that can better be accomplished by the set-aside than by the immediate payment of funds; and (C) Evidences the set-aside by the entry of a dollar amount on the books and records of the supporting organiza-tion as a pledge or obligation to be paid at a future date or dates within 60 months of the set aside. (7) Carryover of excess amounts(i) In general. If with respect to any taxable year, an excess amount, as defined in paragraph (i)(7)(ii) of this section, is created, such excess amount may be used to reduce the distributable amount in any of the five taxable years immediately following the taxable year in which the excess amount is created. An excess amount created in a taxable year can only be carried over for five taxable years. (ii) Excess amount. An excess amount is created for any taxable year begin-ning after December 28, 2012, if the total distributions made in that tax-able year that count toward the dis-tribution requirement exceed the sup-porting organizations distributable amount for the taxable year, as deter-mined under 1.509(a)4T(i)(5)(ii)(B). VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00146 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150137 Internal Revenue Service, Treasury 1.509(a)4 With respect to any taxable year to which an excess amount is carried over, in determining whether an excess amount is created in that taxable year, the distributable amount is first re-duced by any excess amounts carried over (with the oldest excess amounts applied first) and then by any distribu-tions made in that taxable year. (8) Valuation of non-exempt-use assets. [Reserved] For further guidance, see 1.509(a)4T(i)(8). (9) Alternate integral part test for cer-tain trusts. A trust (whether or not ex-empt from taxation under section 501(a)) that on November 20, 1970, met and continues to meet the require-ments of paragraphs (i)(9)(i) through (i)(9)(v) of this section, shall be treated as meeting the requirements of para-graph (i)(5) of this section if for taxable years beginning after October 16, 1972, the trustee of such trust makes annual written reports to all of the trusts sup-ported organizations, setting forth a description of the trusts assets, in-cluding a detailed list of the assets and the income produced by such assets. A trust that meets the requirements of this paragraph (i)(9) may request a rul-ing that it is described in section 509(a)(3) in such manner as the Com-missioner may prescribe. The require-ments of this paragraph (i)(9) are as follows: (i) All the unexpired interests in the trust are devoted to one or more pur-poses described in section 170(c)(1) or (c)(2)(B) and a deduction was allowed with respect to such interests under sections 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), 2522, or corresponding provisions of prior law (or would have been allowed such a deduction if the trust had not been created before 1913). (ii) The trust was created prior to November 20, 1970, and did not receive any grant, contribution, bequest or other transfer on or after such date. For purposes of this paragraph (i)(9)(ii), a split-interest trust described in sec-tion 4947(a)(2) that was created prior to November 20, 1970, was irrevocable on such date, and that becomes a chari-table trust described in section 4947(a)(1) after such date shall be treat-ed as having been created prior to such date. (iii) The trust is required by its gov-erning instrument to distribute all of its net income currently to a des-ignated beneficiary supported organi-zation. If more than one beneficiary supported organization is designated in the governing instrument of a trust, all of the net income must be distributable and must be distributed currently to each of such supported organizations in fixed shares pursuant to such gov-erning instrument. For purposes of this paragraph (i)(9)(iii), the governing in-strument of a charitable trust shall be treated as requiring distribution to a designated supported organization when the trust instrument describes the charitable purpose of the trust so completely that such description can apply to only one existing supported organization and is of sufficient par-ticularity as to vest in such organiza-tion rights against the trust enforce-able in a court possessing equitable powers. (iv) The trustee of the trust does not have discretion to vary either the bene-ficiary supported organizations or the amounts payable to the supported or-ganizations. For purposes of this para-graph (i)(9)(iv), a trustee shall not be treated as having such discretion if the trustee has discretion to make pay-ments of principal to the single sup-ported organization that is currently entitled to receive all of the trusts in-come or if the trust instrument pro-vides that the trustee may cease mak-ing income payments to a particular supported organization in the event of certain specific occurrences, such as the loss of exemption under section 501(c)(3) or classification under section 509(a)(1) or (a)(2) by the supported orga-nization or the failure of the supported organization to carry out its charitable purpose properly. (v) None of the trustees would be dis-qualified persons within the meaning of section 4946(a) (other than foundation managers under section 4946(a)(1)(B)) with respect to the trust if such trust were treated as a private foundation. (10) Foreign supported organizations. A supporting organization is not operated in connection with one or more sup-ported organizations if it supports any supported organization organized out-side of the United States. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00147 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150138 26 CFR Ch. I (4113 Edition) 1.509(a)4 (11) Transition rules(i) Notification requirement. A Type III supporting or-ganization will be treated as having satisfied the notification requirement described in paragraph (i)(2) of this sec-tion for its taxable year that includes December 28, 2012, if the required noti-fication is postmarked or electroni-cally transmitted by the later of the last day of the fifth calendar month following the close of that taxable year or the due date (including extensions) of the supporting organizations annual information return described in section 6033 for that taxable year. (ii) Integral part test(A) Qualification as a functionally integrated Type III sup-porting organization. A Type III sup-porting organization in existence on December 28, 2012, that met and con-tinues to meet the requirements of Treas. Reg. 1.509(a)4(i)(3)(ii), as in ef-fect prior to December 28, 2012, will be treated as meeting the requirements of paragraph (i)(4) of this section until the first day of the organizations sec-ond taxable year beginning after De-cember 28, 2012. (B) Qualification as a non-functionally integrated Type III supporting organiza-tion. A Type III supporting organiza-tion in existence on December 28, 2012, that met and continues to meet the re-quirements of Treas. Reg. 1.509(a) 4(i)(3)(iii), as in effect prior to Decem-ber 28, 2012, will be treated as meeting the requirements of paragraph (i)(5)(i)(A) of this section until the first day of its second taxable year begin-ning after December 28, 2012. Notwith-standing the foregoing, in determining whether an excess amount is created under paragraph (i)(7)(ii) of this section in the first taxable year beginning after December 28, 2012, the distribut-able amount for that taxable year of a Type III supporting organization treat-ed as meeting the requirements of paragraph (i)(5)(i)(A) of this section under this paragraph (i)(11)(ii)(B) is the amount described in 1.509(a) 4T(i)(5)(ii)(B). (C) Transitioning to a non-functionally integrated Type III supporting organiza-tion in the first taxable year after effec-tive date. A Type III supporting organi-zation in existence on December 28, 2012, that meets the requirements of Treas. Reg. 1.509(a)4(i)(3)(ii), as in ef-fect prior to December 28, 2012, in its taxable year including December 28, 2012, but not in its first taxable year beginning after December 28, 2012, is a non-functionally integrated Type III supporting organization and will be treated as having a distributable amount of zero for purposes of meeting the requirements of paragraph (i)(5)(i)(A) of this section during the or-ganizations first taxable year begin-ning after December 28, 2012. Notwith-standing the foregoing, in determining whether an excess amount is created under paragraph (i)(7)(ii) of this section in the first taxable year beginning after December 28, 2012, the distribut-able amount for that taxable year of a Type III supporting organization de-scribed in this paragraph (i)(11)(ii)(C) is the amount described in 1.509(a) 4T(i)(5)(ii)(B), determined without re-gard to paragraph (i)(5)(ii)(D) of this section. (D) Second taxable year after effective date. Beginning in the second taxable year beginning after December 28, 2012, and in all succeeding taxable years, all Type III supporting organizations de-scribed in this paragraph (i)(11)(ii) must meet either the requirements of paragraph (i)(4) or (i)(5) of this section. If a Type III supporting organization described in paragraph (i)(11)(ii)(A) of this section does not meet the require-ments of paragraph (i)(4) of this section during its second taxable year begin-ning after December 28, 2012, its dis-tributable amount for that second tax-able year will be determined under 1.509(a)4T(i)(5)(ii)(B), without regard to paragraph (i)(5)(ii)(D) of this sec-tion. Any Type III supporting organiza-tion intending to meet the require-ments of paragraph (i)(5) of this section in its second taxable year beginning after December 28, 2012, must value its assets in accordance with 1.509(a) 4T(i)(8) beginning in its first taxable year beginning after December 28, 2012. (E) Judicial proceedings to reform in-struments. During any taxable years in which there is pending a judicial pro-ceeding that meets the requirements of this paragraph (i)(11)(ii)(E), a non-func-tionally integrated Type III supporting organization organized before Sep-tember 24, 2009, will not have to comply with the distribution requirement VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00148 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150139 Internal Revenue Service, Treasury 1.509(a)4 under paragraph (i)(5)(ii) of this section to the extent such compliance would be inconsistent with mandatory provi-sions of a governing instrument or other instrument executed before Sep-tember 24, 2009, that prohibits distrib-uting capital or corpus. Beginning with the first taxable year following the taxable year in which such judicial pro-ceeding is terminated, such a non-func-tionally integrated Type III supporting organization must satisfy the distribu-tion requirement under paragraph (i)(5)(ii) of this section, regardless of the outcome of the judicial proceeding. Thus, if, during a taxable year after such a judicial proceeding, an organiza-tion fails to comply with paragraph (i)(5)(ii) of this section, the organiza-tion will not qualify as a non-function-ally integrated Type III supporting or-ganization, regardless of whether such failure to comply was a result of the organization operating in accordance with its governing instrument or other instrument. To meet the requirements of this paragraph (i)(11)(ii)(E), a judi-cial proceeding must be (1) Necessary to reform, or to excuse the supporting organization from com-pliance with, a governing instrument or other instrument (as in effect on September 24, 2009, and all times there-after) in order to permit the organiza-tion to satisfy paragraph (i)(5)(ii) of this section; (2) Commenced before June 26, 2013; and (3) Not subject to any unreasonable delay for which the supporting organi-zation is responsible. (j) Control by disqualified persons(1) In general. Under the provisions of sec-tion 509(a)(3)(C) a supporting organiza-tion may not be controlled directly or indirectly by one or more disqualified persons (as defined in section 4946) other than foundation managers and other than one or more publicly sup-ported organizations. If a person who is a disqualified person with respect to a supporting organization, such as a sub-stantial contributor to the supporting organization, is appointed or des-ignated as a foundation manager of the supporting organization by a publicly supported beneficiary organization to serve as the representative of such pub-licly supported organization, then for purposes of this paragraph such person will be regarded as a disqualified per-son, rather than as a representative of the publicly supported organization. An organization will be considered con-trolled, for purposes of section 509(a)(3)(C), if the disqualified persons, by aggregating their votes or positions of authority, may require such organi-zation to perform any act which sig-nificantly affects its operation or may prevent such organization from per-forming such act. This includes, but is not limited to, the right of any sub-stantial contributor or his spouse to designate annually the recipients, from among the publicly supported organiza-tions of the income attributable to his contribution to the supporting organi-zation. Except as provided in subpara-graph (2) of this paragraph, a sup-porting organization will be considered to be controlled directly or indirectly by one or more disqualified persons if the voting power of such persons is 50 percent or more of the total voting power of the organizations governing body or if one or more of such persons have the right to exercise veto power over the actions of the organization. Thus, if the governing body of a foun-dation is composed of five trustees, none of whom has a veto power over the actions of the foundation, and no more than two trustees are at any time disqualified persons, such foundation will not be considered to be controlled directly or indirectly by one or more disqualified persons by reason of this fact alone. However, all pertinent facts and circumstances including the na-ture, diversity, and income yield of an organizations holdings, the length of time particular stocks, securities, or other assets are retained, and its man-ner of exercising its voting rights with respect to stocks in which members of its governing body also have some in-terest, will be taken into consideration in determining whether a disqualified person does in fact indirectly control an organization. (2) Proof of independent control. Not-withstanding subparagraph (1) of this paragraph, an organization shall be permitted to establish to the satisfac-tion of the Commissioner that disquali-fied persons do not directly or indi-rectly control it. For example, in the VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00149 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150140 26 CFR Ch. I (4113 Edition) 1.509(a)4T case of a religious organization oper-ated in connection with a church, the fact that the majority of the organiza-tions governing body is composed of lay persons who are substantial con-tributors to the organization will not disqualify the organization under sec-tion 509(a)(3)(C) if a representative of the church, such as a bishop or other official, has control over the policies and decisions of the organization. (k) Organizations operated in conjunc-tion with certain section 501(c) (4), (5), or (6) organizations. (1) For purposes of section 509(a)(3), an organization which is operated in conjunction with an or-ganization described in section 501(c) (4), (5), or (6) (such as a social welfare organization, labor or agricultural or-ganization, business league, or real es-tate board) shall, if it otherwise meets the requirements of section 509(a)(3), be considered an organization described in section 509(a)(3) if such section 501(c) (4), (5), or (6) organization would be de-scribed in section 509(a)(2) if it were an organization described in section 501(c)(3). The section 501(c) (4), (5), or (6) organization, which the supporting organization is operating in conjunc-tion with, must therefore meet the one-third tests of a publicly supported organization set forth in section 509(a)(2). (2) This paragraph may be illustrated by the following example: Example. X medical association, described in section 501(c)(6), is supported by member-ship dues and funds resulting from the per-formance of its exempt activities. This sup-port, which is entirely from permitted sources, constitutes more than one-third of Xs support. X does not normally receive more than one-third of its support from items described in section 509(a)(2)(B). X or-ganized and operated an endowment fund for the sole purpose of furthering medical edu-cation. The fund is an organization described in section 501(c)(3). Since more than one- third of Xs support is derived from member-ship dues and from funds resulting from the performance of exempt purposes (all of which are from permitted sources) and not more than one-third of its support is from items described in section 509(a)(2)(B), it would be a publicly supported organization described in section 509(a)(2) if it were described in sec-tion 501(c)(3) rather than section 501(c)(6). Accordingly, if the fund otherwise meets the requirements of section 509(a)(3) with respect to X, it will be considered an organization described in section 509(a)(3). (l) Effective/applicability date. Para-graphs (a)(6), (f)(5), and (i) of this sec-tion are effective on December 28, 2012. [T.D. 7212, 37 FR 21916, Oct. 17, 1972, as amended by T.D. 7784, 46 FR 37890, July 23, 1981; 77 FR 76394, Dec. 28, 2012] 1.509(a)4T Supporting organizations (temporary). (a) through (i)(5)(ii)(A) [Reserved] For further guidance, see 1.509(a)4(a) through (i)(5)(ii)(A). (B) Distributable amount. Except as provided in 1.509(a)4(i)(5)(ii)(D) and 1.509(a)4(i)(5)(ii)(E), the distributable amount for a taxable year is an amount equal to the greater of 85 per-cent of the supporting organizations adjusted net income (as determined by applying the principles of section 4942(f) and 53.4942(a)2(d) of this chap-ter) for the taxable year immediately preceding the taxable year of the re-quired distribution (immediately pre-ceding taxable year) or its minimum asset amount (as defined in paragraph (i)(5)(ii)(C) of this section) for the im-mediately preceding taxable year, re-duced by the amount of taxes imposed on the supporting organization under subtitle A of the Internal Revenue Code during the immediately preceding taxable year. (C) Minimum asset amount. For pur-poses of this paragraph (i)(5), a sup-porting organizations minimum asset amount for the immediately preceding taxable year is 3.5 percent of the excess of the aggregate fair market value of all of the supporting organizations non-exempt-use assets (determined under paragraph (i)(8) of this section) in that immediately preceding taxable year over the acquisition indebtedness with respect to such non-exempt-use assets (determined under section 514(c)(1) without regard to the taxable year in which the indebtedness was in-curred), increased by (1) Amounts received or accrued dur-ing the immediately preceding taxable year as repayments of amounts which were taken into account by the organi-zation to meet the distribution require-ment imposed in 1.509(a)4(i)(5)(ii)(A) for any taxable year; (2) Amounts received or accrued dur-ing the immediately preceding taxable year from the sale or other disposition VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00150 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150141 Internal Revenue Service, Treasury 1.509(a)5 of property to the extent that the ac-quisition of such property was taken into account by the organization to meet the distribution requirement im-posed in 1.509(a)4(i)(5)(ii)(A) for any taxable year; and (3) Any amount set aside under 1.509(a)4(i)(6)(v) to the extent it is de-termined during the immediately pre-ceding taxable year that such amount is not necessary for the purposes for which it was set aside and such amount was taken into account by the organi-zation to meet the distribution require-ment imposed in 1.509(a)4(i)(5)(ii)(A) for any taxable year. (i)(5)(ii)(D) through (i)(7) [Reserved] For further guidance, see 1.509(a) 4(i)(5)(ii)(D) through (i)(7). (8) Valuation of non-exempt-use assets. For purposes of determining its distrib-utable amount for a taxable year, a supporting organization determines its minimum asset amount, as defined in paragraph (i)(5)(ii)(C) of this section, by determining the aggregate fair mar-ket value of all of its non-exempt-use assets in the immediately preceding taxable year. For these purposes, the determination of the aggregate fair market value of all non-exempt-use as-sets shall be made using the valuation methods described in 53.4942(a)2(c) of this chapter. The aggregate fair mar-ket value of the supporting organiza-tions non-exempt-use assets shall not be reduced by any amount that is set aside under 1.509(a)4(i)(6)(v). For these purposes, the non-exempt-use as-sets of the supporting organization are all assets of the supporting organiza-tion other than (i) Assets described in 53.4942(a) 2(c)(2)(i) through (iv) of this chapter (with supporting organization being substituted for foundation or pri-vate foundation and August 17, 2006 being substituted for December 31, 1969); and (ii) Exempt-use assets, which are as-sets that are used (or held for use) to carry out the exempt purposes of the supporting organizations supported or-ganization(s) (determined by applying the principles described in 53.4942(a) 2(c)(3) of this chapter) by either (A) The supporting organization; or (B) One or more supported organiza-tions, but only if the supporting orga-nization makes the asset available to the supported organization(s) at no cost (or nominal rent) to the supported organization(s). (i)(9) through (l) [Reserved] For fur-ther guidance, see 1.509(a)4(i)(9) through (l). (m) Effective/applicability date. This section is effective on December 28, 2012. The applicability of this section expires on or before December 21, 2015. [77 FR 76399, Dec. 28, 2012] 1.509(a)5 Special rules of attribu-tion. (a) Retained character of gross invest-ment income. (1) For purposes of deter-mining whether an organization meets the not-more-than-one-third support test set forth in section 509(a)(2)(B), amounts received by such organization from: (i) An organization which seeks to be described in section 509(a)(3) by reason of its support of such organization; or (ii) A charitable trust, corporation, fund, or association described in sec-tion 501(c)(3) (including a charitable trust described in section 4947(a)(1)) or a split interest trust described in sec-tion 4947(a)(2), which is required by its governing instrument or otherwise to distribute, or which normally does dis-tribute, at least 25 percent of its ad-justed net income (within the meaning of section 4942(f)) to such organization, and such distribution normally com-prises at least 5 percent of such dis-tributee organizations adjusted net in-come will retain their character as gross in-vestment income (rather than gifts or contributions) to the extent that such amounts are characterized as gross in-vestment income in the possession of the distributing organization described in subdivision (i) or (ii) of this subpara-graph or, if the distributing organiza-tion is a split interest trust described in section 4947(a)(2), to the extent that such amounts would be characterized as gross investment income attrib-utable to transfers in trust after May 26, 1969, if such trust were a private foundation. For purposes of this sec-tion, all income which is characterized as gross investment income in the pos-session of the distributing organization VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00151 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150142 26 CFR Ch. I (4113 Edition) 1.509(a)5 shall be deemed to be distributed first by such organization and shall retain its character as such in the possession of the recipient of amounts described in this paragraph. If an organization described in subdivision (i) or (ii) of this subparagraph makes distributions to more than one organization, the amount of gross investment income deemed distributed shall be prorated among the distributees. (2) For purposes of subparagraph (1) of this paragraph, amounts paid by an organization to provide goods, services, or facilities for the direct benefit of an organization seeking section 509(a)(2) status (rather than for the direct ben-efit of the general public) shall be treated in the same manner as amounts received by the latter organi-zation. Such amounts will be treated as gross investment income to the extent that such amounts are characterized as gross investment income in the posses-sion of the organization spending such amounts. For example, X is an organi-zation described in subparagraph (1)(i) of this paragraph. It uses part of its funds to provide Y, an organization seeking section 509(a)(2) status, with certain services which Y would other-wise be required to purchase on its own. To the extent that the funds used by X to provide such services for Y are characterized as gross investment in-come in the possession of X, such funds will be treated as gross investment in-come received by Y. (3) An organization seeking section 509(a)(2) status shall file a separate statement with its return required by section 6033, setting forth all amounts received from organizations described in paragraph (a)(1) (i) or (ii) of this sec-tion. (b) Relationships created for avoidance purposes. (1) If a relationship between an organization seeking section 509(a)(3) status and an organization seeking section 509(a)(2) status: (i) Is established or availed of after October 9, 1969, and (ii) One of the purposes of estab-lishing or utilizing such relationship is to avoid classification as a private foundation with respect to either orga-nization, the character and amount of support received by the section 509(a)(3) organization will be attributed to the section 509(a)(2) organization for purposes of determining whether the latter meets the one-third support test and the not-more-than-one-third sup-port test under section 509(a)(2). If a re-lationship described in this subpara-graph is established or utilized by an organization seeking section 509(a)(3) status and two or more organizations seeking section 509(a)(2) status, the amount of support received by the former organization will be prorated among the latter organizations and the character of each class of support (as defined in section 509(d)) will be attrib-uted pro rata to each such organiza-tion. The provisions of this paragraph and of paragraph (a) of this section are not mutually exclusive. (2) In determining whether a rela-tionship between one or more organiza-tions seeking section 509(a)(2) status (hereinafter referred to as beneficiary organizations) and an organization seeking section 509(a)(3) status (herein-after referred to as the supporting orga-nization) has been established or availed of to avoid classification as a private foundation (within the meaning of subparagraph (1) of this paragraph), all pertinent facts and circumstances, including the following, shall be taken into account as evidence that a rela-tionship was not established or availed of to avoid classification as a private foundation: (i) The supporting organization is op-erated to support or benefit several specified beneficiary organizations. (ii) The beneficiary organization has a substantial number of dues-paying members (in relation to the public it serves and the nature of its activities) and such members have an effective voice in the management of both the supporting and beneficiary organiza-tions. (iii) The beneficiary organization is composed of several membership orga-nizations, each of which has a substan-tial number of members (in relation to the public it serves and the nature of its activities), and such membership organizations have an effective voice in the management of the supporting and beneficiary organizations. (iv) The beneficiary organization re-ceives a substantial amount of support VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00152 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150143 Internal Revenue Service, Treasury 1.509(a)6 from the general public, public char-ities, or governmental grants. (v) The supporting organization uses its funds to carry on a meaningful pro-gram of activities to support or benefit the beneficiary organization and such use would, if such supporting organiza-tion were a private foundation, be suf-ficient to avoid the imposition of any tax upon such organization under sec-tion 4942. vi) The supporting organization is not able to exercise substantial control or influence over the beneficiary orga-nization by reason of the formers re-ceiving support or holding assets which are disproportionately large in com-parison with the support received or the assets held by the latter. (vii) Different persons manage the operations of the beneficiary and sup-porting organizations and each organi-zation performs a different function. (3) The provisions of this paragraph may be illustrated by the following ex-amples: Example 1. M, an organization described in section 509(a)(2), is a council composed of 10 learned societies. Each member society has a large membership of scholars interested in a particular academic area. In 1970 M estab-lished N, an organization seeking section 509(a)(3) status, for the purpose of carrying on research and study projects of interest to the member societies. The principal source of funds for Ns activities is from foundation and government grants and contracts. The principal source of funds for Ms activities after the creation of N is membership dues. M continued to maintain a wide variety of activities for its members, such as pub-lishing periodicals and carrying on seminars and conferences. N is subject to complete control by the governing body of M. Under these circumstances, the relationship be-tween these organizations is not one which is described in subparagraph (1) of this para-graph. Example 2. Q is a local medical research or-ganization described in section 509(a)(2). Its fixed assets are negligible and it carries on research activities on a limited scale. It also makes a limited number of grants to sci-entists and doctors who are engaged in med-ical research of interest to Q. It receives sup-port through small government grants and a few research contracts from private founda-tions. R is an organization described in sec-tion 501(c)(3). As of January 1, 1970, R was classified as a private foundation under sec-tion 509. It has a substantial endowment which it uses to make grants to various charitable and scientific organizations de-scribed in section 501(c)(3). During 1970, R agrees to subsidize the research activities of Q. R amends its governing instrument to provide specifically that all of Rs support will be used for research activities which are approved and supervised by Q. R also amends its bylaws to permit a minority of Qs board of directors to be members of Rs governing body. R then gives timely notification under section 507(b)(1)(B)(ii) that R is terminating its private foundation status by meeting the requirements of section 509(a)(3) by the end of the 12-month period described in section 507(b)(1)(B)(i). For purposes of determining whether R has met the requirements of sec-tion 509(a)(3) by the end of the 12-month pe-riod, as well as determining Qs status under section 509(a)(2), the character and amount of support received by R will be attributed to Q. (c) Effect on organizations claiming sec-tion 509(a)(3) status. If an organization claiming section 509(a)(2) status fails to meet either the one-third support test or the not-more-than-one-third support test under section 509(a)(2) by reason of the application of the provi-sions of paragraph (a) or (b) of this sec-tion, and such organization is one of the specified organizations (within the meaning of section 509(a)(3)(A)) for whose support or benefit an organiza-tion claiming section 509(a)(3) status is operated, the organization claiming section 509(a)(3) status will not be con-sidered to be operated exclusively to support or benefit one or more section 509(a) (1) or (2) organizations. [T.D. 7212, 37 FR 21922, Oct. 17, 1972, as amended by T.D. 7290, 38 FR 31834, Nov. 19, 1973; T.D. 7784, 46 FR 37890, July 23, 1981] 1.509(a)6 Classification under sec-tion 509(a). If an organization is described in sec-tion 509(a)(1) and also in another para-graph of section 509(a), it will be treat-ed as described in section 509(a)(1). For purposes of this section, the parenthet-ical language other than in clauses (vii) and (viii) used in section 509(a)(1) shall be construed to mean other than an or-ganization which is described only in clause (vii) or (viii). For example, X is an organization which is described in section 170(b)(1)(A)(vi), but could also meet the description of section 170(b)(1)(A)(viii) as an organization de-scribed in section 509(a)(2). For pur-poses of the one-third support test in section 509(a)(2)(A), contributions from VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00153 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150144 26 CFR Ch. I (4113 Edition) 1.509(a)7 X to other organizations will be treat-ed as support from an organization de-scribed in section 170(b)(1)(A)(vi) rather than from an organization described in section 170(b)(1)(A)(viii). [T.D. 7212, 37 FR 21923, Oct. 17, 1972] 1.509(a)7 Reliance by grantors and contributors to section 509(a) (1), (2), and (3) organizations. (a) General rule. Once an organization has received a final ruling or deter-mination letter classifying it as an or-ganization described in section 509(a) (1), (2), or (3), the treatment of grants and contributions and the status of grantors and contributors to such orga-nization under sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522 will not be affected by reason of a subsequent revocation by the service of the organizations classification as described in section 509(a) (1), (2), or (3) until the date on which notice of change of status is made to the public (such as by publica-tion in the Internal Revenue Bulletin) or another applicable date, if any, spec-ified in such public notice. In appro-priate cases, however, the treatment of grants and contributions and the sta-tus of grantors and contributors to an organization described in section 509(a) (1), (2), or (3) may be affected pending verification of the continued classifica-tion of such organization under section 509(a) (1), (2), or (3). Notice to this af-fect will be made in a public announce-ment by the service. In such cases the effect of grants and contributions made after the date of the announcement will depend upon the statutory quali-fication of the organization as an orga-nization described in section 509(a) (1), (2), or (3). (b) Exceptions. (1) Paragraph (a) of this section shall not apply if the grantor or contributor: (i) Had knowledge of the revocation of the ruling or determination letter classifying the organization as an orga-nization described in section 509(a) (1), (2), or (3), or (ii) Was in part responsible for, or was aware of, the act, the failure to act, or the substantial and material change on the part of the organization which gave rise to the revocation of the ruling or determination letter classifying the organization as an orga-nization described in section 509(a) (1), (2), or (3). (2) Paragraph (a) of this section shall not apply where a different rule is oth-erwise expressly provided in the regula-tions under sections 170(b)(1)(A), 507(b)(1)(B), or 509. [T.D. 7212, 37 FR 21923, Oct. 17, 1972] 1.509(b)1 Continuation of private foundation status. (a) In general. If an organization is a private foundation (within the meaning of section 509(a)) on October 9, 1969, or becomes a private foundation on any subsequent date, such organization shall be treated as a private foundation for all periods after October 9, 1969, or after such subsequent date, unless its status as such is terminated under sec-tion 507. Therefore, if an organization was described in section 501(c)(3) and was a private foundation within the meaning of section 509(a) on October 9, 1969, it shall be treated as a private foundation for all periods thereafter, even though it may also satisfy the re-quirements of an organization de-scribed in some other paragraph of sec-tion 501(c). For example, if on October 9, 1969, an organization was described in section 501(c)(3), but because of its activities, it could also have qualified as an organization described in section 501(c)(4), such organization will con-tinue to be treated as a private founda-tion, if it was a private foundation within the meaning of section 509(a) on October 9, 1969. (b) Taxable private foundations. If an organization is a private foundation on October 9, 1969, and it is determined that it is not exempt under section 501(a) as an organization described in section 501(c)(3) as of any date after Oc-tober 9, 1969, such organization, even though it may operate thereafter as a taxable entity, will continue to be treated as a private foundation unless its status as such is terminated under section 507. For example, X organiza-tion is a private foundation on October 9, 1969. It is subsequently determined that, as of July 1, 1972, X is no longer exempt under section 501(a) as an orga-nization described in section 501(c)(3) VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00154 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150145 Internal Revenue Service, Treasury 1.5112 because, for example, it has not con-formed its governing instrument pursu-ant to section 508(e). X will continue to be treated as a private foundation after July 1, 1972, unless its status as such is terminated under section 507. However, if an organization is not exempt under section 501(a) as an organization de-scribed in section 501(c)(3) on October 9, 1969, then it will not be treated as a private foundation within the meaning of section 509(a) by reason of section 509(b), unless it becomes a private foun-dation on a subsequent date. [T.D. 7212, 37 FR 21924, Oct. 17, 1972] 1.509(c)1 Status of organization after termination of private founda-tion status. (a) In general. For purposes of part II of subchapter F of this chapter, an or-ganization whose status as a private foundation is terminated under section 507 shall be treated as an organization created on the day after the date of such termination. An organization whose private foundation status has been terminated under the provisions of section 507(a) will, if it continues to operate, be treated as a new organiza-tion and must, if it desires to be classi-fied under section 501(c)(3), give notifi-cation that it is applying for recogni-tion of section 501(c)(3) status pursuant to the provisions of section 508(a). (b) Effect upon section 507(d)(1). If the private foundation status of an organi-zation has been terminated under sec-tion 507(b)(1)(B) and the regulations thereunder, and: (1) Such organization does not con-tinue at all times thereafter to meet the requirements of section 509(a) (1), (2), or (3) (and is therefore no longer ex-cluded from the definition of a private foundation); and (2) The status of such organization as a private foundation is thereafter ter-minated under section 507(a) then the tax imposed under section 507(c)(1) upon the aggregate tax benefit (described in section 507(d)(1)) resulting from section 501(c)(3) status shall be computed only upon the aggregate tax benefit resulting after the date on which the organization again becomes a private foundation under subpara-graph (1) of this paragraph. [T.D. 7212, 37 FR 21924, Oct. 17, 1972] 1.509(d)1 Definition of support For purposes of section 509(a)(2), the term support does not include amounts received in repayment of the principal of a loan or other indebtedness. See, however, section 509(e) as to amounts received as interest on a loan or other indebtedness. [T.D. 7212, 37 FR 21924, Oct. 17, 1972] 1.509(e)1 Definition of gross invest-ment income. For the distinction between gross re-ceipts and gross investment income, see 1.509(a)3(m). (Sec. 7805, Internal Revenue Code of 1954, 68A Stat. 917; 26 U.S.C. 7805) [T.D. 7212, 37 FR 21925, Oct. 17, 1972] TAXATION OF BUSINESS INCOME OF CERTAIN EXEMPT ORGANIZATIONS 1.5111 Imposition and rates of tax. Section 511(a) imposes a tax upon the unrelated business taxable income of certain organizations otherwise exempt from Federal income tax. Under sec-tion 511(a)(1), organizations described in section 511(a)(2)(A) and in paragraph (a) of 1.5112 and organizations de-scribed in section 511(a)(2)(B) are sub-ject to normal tax and surtax at the corporate rates provided by section 11. Under section 511(b)(1), trusts described in section 511(b)(2) are subject to tax at the individual rates prescribed in sec-tion 1(d) of the Code as amended by the Tax Reform Act of 1969 (section 1 for taxable years ending before Jan. 1, 1971). The deduction for personal ex-emption provided in section 642(b) in the case of a trust taxable under sub-chapter J, chapter 1 of the Code, is not allowed in computing unrelated busi-ness taxable income. [T.D. 7117, 36 FR 9421, May 25, 1971] 1.5112 Organizations subject to tax. (a) Organizations other than trusts and title holding companies. (1)(i) The taxes imposed by section 511(a)(1) apply in the case of any organization (other than a trust described in section VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00155 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150146 26 CFR Ch. I (4113 Edition) 1.5112 511(b)(2) or an organization described in section 501(c)(1)) which is exempt from taxation under section 501(a) (except as provided in sections 507 through 515). For special rules concerning corpora-tions described in section 501(c)(2), see paragraph (c) of this section. (ii) In the case of an organization de-scribed in section 501(c)(4), (7), (8), (9), (10), (11), (12), (13), (14)(A), (15), (16), or (18), the taxes imposed by section 511(a)(1) apply only for taxable years beginning after December 31, 1969. In the case of an organization described in section 501(c)(14) (B) or (C), the taxes imposed by section 511(a)(1) apply only for taxable years beginning after Feb-ruary 2, 1966. (2) The taxes imposed by section 511(a) apply in the case of any college or university which is an agency or in-strumentality of any government or any political subdivision thereof, or which is owned or operated by a gov-ernment or any political subdivision thereof or by any agency or instrumen-tality of any one or more governments or political subdivisions. Such taxes also apply in the case of any corpora-tion wholly owned by one or more such colleges or universities. As here used, the word government includes any for-eign government (to the extent not contrary to any treaty obligation of the United States) and all domestic governments (the United States and any of its Territories or possessions, any State, and the District of Colum-bia). Elementary and secondary schools operated by such governments are not subject to the tax on unrelated busi-ness income. (3)(i) For taxable years beginning be-fore January 1, 1970, churches and asso-ciations or conventions of churches are exempt from the taxes imposed by sec-tion 511. The exemption is applicable only to an organization which itself is a church or an association or conven-tion of churches. Subject to the provi-sions of subdivision (ii) of this subpara-graph, religious organizations, includ-ing religious orders, if not themselves churches or associations or conven-tions of churches, and all other organi-zations which are organized or oper-ated under church auspices, are subject to the tax imposed by section 511, whether or not they engage in reli-gious, educational, or charitable ac-tivities approved by a church. (ii) The term church includes a reli-gious order or a religious organization if such order or organization (a) is an integral part of a church, and (b) is en-gaged in carrying out the functions of a church, whether as a civil law cor-poration or otherwise. In determining whether a religious order or organiza-tion is an integral part of a church, consideration will be given to the de-gree to which it is connected with, and controlled by, such church. A religious order or organization shall be consid-ered to be engaged in carrying out the functions of a church if its duties in-clude the ministration of sacerdotal functions and the conduct of religious worship. If a religious order or organi-zation is not an integral part of a church, or if such an order or organiza-tion is not authorized to carry out the functions of a church (ministration of sacerdotal functions and conduct of re-ligious worship) then it is subject to the tax imposed by section 511 whether or not it engages in religious, edu-cational, or charitable activities ap-proved by a church. What constitutes the conduct of religious worship or the ministration of sacerdotal functions depends on the tenets and practices of a particular religious body consti-tuting a church. If a religious order or organization can fully meet the re-quirements stated in this subdivision, exemption from the tax imposed by section 511 will apply to all its activi-ties, including those which it conducts through a separate corporation (other than a corporation described in section 501(c)(2)) or other separate entity which it wholly owns and which is not operated for the primary purpose of carrying on a trade or business for profit. Such exemption from tax will also apply to activities conducted through a separate corporation (other than a corporation described in section 501(c)(2)) or other separate entity which is wholly owned by more than one religious order or organization, if all such orders or organizations fully meet the requirements stated in this subdivision and if such corporation or other entity is not operated for the pri-mary purpose of carrying on a trade or business for profit. VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00156 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150147 Internal Revenue Service, Treasury 1.5112 (iii) For taxable years beginning after December 31, 1969, churches and conventions or associations of churches are subject to the taxes imposed by section 511, unless otherwise entitled to the benefit of the transitional rules of section 512(b)(14) and 1.512(b)1(i). (b) Trusts(1) In general. The taxes imposed by section 511(b) apply in the case of any trust which is exempt from taxation under section 501(a) (except as provided in sections 507 through 515), and which, if it were not for such ex-emption, would be subject to the provi-sions of subchapter J, chapter 1, of the Code. An organization which is consid-ered as trustee of a stock bonus, pen-sion, or profit-sharing plan described in section 401(a), a supplemental unem-ployment benefit trust described in section 501(c)(17), or a pension plan de-scribed in section 501(c)(18) (regardless of the form of such organization) is subject to the taxes imposed by section 511(b)(1) on its unrelated business in-come. However, if such an organization conducts a business which is a separate taxable entity on the basis of all the facts and circumstances, for example, an association taxable as a corpora-tion, the business will be taxable as a feeder organization described in sec-tion 502. (2) Effective dates. In the case of a trust described in section 501(c)(3), the taxes imposed by section 511(b) apply for taxable years beginning after De-cember 31, 1953. In the case of a trust described in section 401(a), the taxes imposed by section 511(b) apply for tax-able years beginning after June 30, 1954. In the case of a trust described in section 501(c)(17), the taxes imposed by section 511(b) apply for taxable years beginning after December 31, 1959. In the case of any other trust described in subparagraph (1) of this paragraph, the taxes imposed by section 511(b) apply for taxable years beginning after De-cember 31, 1969. (c) Title Holding Companies(1) In general. If a corporation described in section 501(c)(2) pays any amount of its net income for a taxable year to an or-ganization exempt from taxation under section 501(a) (or would pay such an amount but for the fact that the ex-penses of collecting its income exceed its income), and if such corporation and such organization file a consoli-dated income tax return for such tax-able year, then such corporation shall be treated, for purposes of the tax im-posed by section 511(a), as being orga-nized and operated for the same pur-poses as such organization, as well as for its title-holding purpose. Therefore, if an item of income of the section 501(c)(2) corporation is derived from a source which is related to the exempt function of the exempt organization to which such income is payable and with which such corporation files a consoli-dated return, such item is, together with all deductions directly connected therewith, excluded from the deter-mination of unrelated business taxable income under section 512 and shall not be subject to the tax imposed by sec-tion 511(a). If, however, such item of in-come is derived from a source which is not so related, then such item, less all deductions directly connected there-with, is, subject to the modifications provided in section 512(b), unrelated business taxable income subject to the tax imposed by section 511(a). (2) The provisions of subparagraph (1) of this paragraph may be illustrated by the following example: Example. The income of X, a section 501(c)(2) corporation, is required to be dis-tributed to exempt organization A. During the taxable year X realizes net income of $900,000 from source M and $100,000 from source N. Source M is related to As exempt function, while source N is not so related. X and A file a consolidated return for such tax-able year. X has net unrelated business in-come of $100,000, subject to the modifications in section 512(b). (3) Cross reference. For rules relating generally to the filing of consolidated returns by certain organizations ex-empt from taxation under section 501(a), see section 1504(e) of the Code and 1.1502100. (4) Effective dates. Subparagraphs (1) through (3) of this paragraph apply with respect to taxable years beginning after December 31, 1969. For taxable years beginning before January 1, 1970, a corporation described in section 501(c)(2) and otherwise exempt from taxation under section 501(a) is taxable upon its unrelated business taxable in-come only if such income is payable ei-ther: VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00157 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150148 26 CFR Ch. I (4113 Edition) 1.5113 (i) To a church or convention or asso-ciation of churches, or (ii) To any organization subject, for taxable years beginning before January 1, 1970, to the tax imposed by section 511(a)(1). (d) The fact that any class of organi-zations exempt from taxation under section 501(a) is subject to the unre-lated business income tax under sec-tion 511 and this section does not in any way enlarge the permissible scope of business activities of such class for purposes of the continued qualification of such class under section 501(a). [T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7183, 37 FR 7884, Apr. 21, 1972; T.D. 7632, 44 FR 42681, July 20, 1979] 1.5113 Provisions generally applica-ble to the tax on unrelated business income. (a) Assessment and collections. Since the taxes imposed by section 511 are taxes imposed by subtitle A of the Code, all provisions of law and of the regulations applicable to the taxes im-posed by subtitle A are applicable to the assessment and collection of the taxes imposed by section 511. Organiza-tions subject to the tax imposed by sec-tion 511(a)(1) are subject to the same provisions, including penalties, as are provided in the case of the income tax of other corporations. In the case of a trust subject to the tax imposed by sec-tion 511(b)(1), the fiduciaries for such trust are subject to the same provi-sions, including penalties, as are appli-cable to fiduciaries in the case of the income tax of other trusts. See section 6151, et seq., and the regulations pre-scribed thereunder, for provisions re-lating to payment of tax. (b) Returns. For requirements of fil-ing annual returns with respect to un-related business taxable income by or-ganizations subject to the tax on such income, see section 6012, paragraph (e) of 1.60122, and paragraph (a)(5) of 1.60123. (c) Taxable years, method of account-ing, etc. The taxable year (fiscal year or calendar year, as the case may be) of an organization shall be determined without regard to the fact that such or-ganization may have been exempt from tax during any prior period. See sec-tions 441 and 446, and the regulations thereunder in this part, and section 7701 and the regulations in part 301 of this chapter (Regulations on Procedure and Administration). Similarly, in computing unrelated business taxable income, the determination of the tax-able year for which an item of income or expense is taken into account shall be made under the provisions of sec-tions 441, 446, 451, and 461, and the regu-lations thereunder, whether or not the item arose during a taxable year begin-ning before, on, or after the effective date of the provisions imposing a tax upon unrelated business taxable in-come. If a method for treating bad debts was selected in a return of in-come (other than an information re-turn) for a previous taxable year, the taxpayer must follow such method in its returns under section 511, unless such method is changed in accordance with the provisions of 1.1661. A tax-payer which has not previously se-lected a method for treating bad debts may, in its first return under section 511, exercise the option granted in 1.1661. (d) Foreign tax credit. See section 515 for provisions applicable to the credit for foreign taxes provided in section 901. 1.5114 Minimum tax for tax pref-erences. The tax imposed by section 56 applies to an organization subject to tax under section 511 with respect to items of tax preference which enter into the com-putation of unrelated business taxable income. For this purpose, only those items of income and those deductions entering into the determination of the tax imposed by this section are consid-ered in the determination of the items of tax preference under section 57. For rules relating to the minimum tax for tax preferences, see sections 56 through 58 and the regulations thereunder. [T.D. 7564, 43 FR 40494, Sept. 12, 1978] 1.512(a)1 Definition. (a) In general. Except as otherwise provided in 1.512(a)3, 1.512(a)4, or paragraph (f) of this section, section 512(a)(1) defines unrelated business tax-able income as the gross income derived from any unrelated trade or business VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00158 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150149 Internal Revenue Service, Treasury 1.512(a)1 regularly carried on, less those deduc-tions allowed by chapter 1 of the Code which are directly connected with the carrying on of such trade or business, subject to certain modifications re-ferred to in 1.512(b)1. To be deduct-ible in computing unrelated business taxable income, therefore, expenses, depreciation, and similar items not only must qualify as deductions al-lowed by chapter 1 of the Code, but also must be directly connected with the carrying on of unrelated trade or busi-ness. Except as provided in paragraph (d)(2) of this section, to be directly con-nected with the conduct of unrelated business for purposes of section 512, an item of deduction must have proximate and primary relationship to the car-rying on of that business. In the case of an organization which derives gross in-come from the regular conduct of two or more unrelated business activities, unrelated business taxable income is the aggregate of gross income from all such unrelated business activities less the aggregate of the deductions al-lowed with respect to all such unre-lated business activities. For the treat-ment of amounts of income or loss of common trust funds, see 1.5842(c)(3). (b) Expenses attributable solely to unre-lated business activities. Expenses, depre-ciation, and similar items attributable solely to the conduct of unrelated busi-ness activities are proximately and pri-marily related to that business activ-ity, and therefore qualify for deduction to the extent that they meet the re-quirements of section 162, section 167, or other relevant provisions of the Code, connected with the conduct of that activity and are deductible in computing unrelated business activi-ties are directly connected with the conduct of that activity and are de-ductible in computing unrelated busi-ness taxable income if they otherwise qualify for deduction under the re-quirements of section 162. Similarly, depreciation of a building used entirely in the conduct of unrelated business activities would be an allowable deduc-tion to the extent otherwise permitted by section 167. (c) Dual use of facilities or personnel. Where facilities are used both to carry on exempt activities and to conduct unrelated trade or business activities, expenses, depreciation and similar items attributable to such facilities (as, for example, items of overhead), shall be allocated between the two uses on a reasonable basis. Similarly, where personnel are used both to carry on ex-empt activities and to conduct unre-lated trade or business activities, ex-penses and similar items attributable to such personnel (as, for example, items of salary) shall be allocated be-tween the two uses on a reasonable basis. The portion of any such item so allocated to the unrelated trade or business activity is proximately and primarily related to that business ac-tivity, and shall be allowable as a de-duction in computing unrelated busi-ness taxable income in the manner and to the extent permitted by section 162, section 167, or other relevant provi-sions of the Code. Thus, for example, assume that X, an exempt organization subject to the provisions of section 511, pays its president a salary of $20,000 a year. X derives gross income from the conduct of unrelated trade or business activities. The president devotes ap-proximately 10 percent of his time dur-ing the year to the unrelated business activity. For purposes of computing Xs unrelated business taxable income, a deduction of $2,000 (10 percent of $20,000), would be allowable for the sal-ary paid to its president. (d) Exploitation of exempt activities(1) In general. In certain cases, gross in-come is derived from an unrelated trade or business activity which ex-ploits an exempt activity. One example of such exploitation is the sale of ad-vertising in a periodical of an exempt organization which contains editorial material related to the accomplish-ment of the organizations exempt pur-pose. Except as specified in subpara-graph (2) of this paragraph and para-graph (f) of this section, in such cases, expenses, depreciation and similar items attributable to the conduct of the exempt activities are not deduct-ible in computing unrelated business taxable income. Since such items are incident to an activity which is carried on in furtherance of the exempt pur-pose of the organization, they do not possess the necessary proximate and primary relationship to the unrelated trade or business activity and are VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00159 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150150 26 CFR Ch. I (4113 Edition) 1.512(a)1 therefore not directly connected with that business activity. (2) Allowable deductions. Where an un-related trade or business activity is of a kind carried on for profit by taxable organizations and where the exempt activity exploited by the business is a type of activity normally conducted by taxable organizations in pursuance of such business, expenses, depreciation, and similar items which are attrib-utable to the exempt activity qualify as directly connected with the carrying on of the unrelated trade or business activity to the extent that: (i) The aggregate of such items ex-ceeds the income (if any) derived from or attributable to the exempt activity; and (ii) The allocation of such excess to the unrelated trade or business activ-ity does not result in a loss from such unrelated trade or business activity Under the rule of the preceding sen-tence, expenses, depreciation and simi-lar items paid or incurred in the per-formance of an exempt activity must be allocated first to the exempt activ-ity to the extent of the income derived from or attributable to the perform-ance of that activity. Furthermore, such items are in no event allocable to the unrelated trade or business activ-ity exploiting such exempt activity to the extent that their deduction would result in a loss carryover or carryback with respect to that trade or business activity. Similarly, they may not be taken into account in computing unre-lated business taxable income attrib-utable to any unrelated trade or busi-ness activity not exploiting the same exempt activity. See paragraph (f) of this section for the application of these rules to periodicals published by ex-empt organizations. (e) Examples. This section is illus-trated by the following examples: Example 1. W is an exempt business league with a large membership. Under an arrange-ment with an advertising agency W regularly mails brochures, pamphlets and other adver-tising materials to its members, charging the agency an agreed amount per enclosure. The distribution of the advertising materials does not contribute importantly to the ac-complishment of the purpose for which W is granted exemption. Accordingly, the pay-ments made to W by the advertising agency constitute gross income from an unrelated trade or business activity. In computing Ws unrelated business taxable income, the ex-penses attributable solely to the conduct of the business, or allocable to such business under the rule of paragraph (c) of this sec-tion, are allowable as deductions in accord-ance with the provisions of section 162. Such deductions include the costs of handling and mailing, the salaries of personnel used full- time in the unrelated business activity and an allocable portion of the salaries of per-sonnel used both to carry on exempt activi-ties and to conduct the unrelated business activity. However, costs of developing Ws membership and carrying on its exempt ac-tivities are not deductible. Those costs are necessary to the maintenance of the intan-gible asset exploited in the unrelated busi-ness activityWs membershipbut are in-curred primarily in connection with Ws fun-damental purpose as an exempt organization. As a consequence, they do not have proxi-mate and primary relationship to the con-duct of the unrelated business activity and do not qualify as directly connected with it. Example 2. (i) P, a manufacturer of photo-graphic equipment, underwrites a photog-raphy exhibition organized by M, an art mu-seum described in section 501(c)(3). In return for a payment of $100,000, M agrees that the exhibition catalog sold by M in connection with the exhibit will advertise Ps product. The exhibition catalog will also include edu-cational material, such as copies of photo-graphs included in the exhibition, interviews with photographers, and an essay by the cu-rator of Ms department of photography. For purposes of this example, assume that none of the $100,000 is a qualified sponsorship pay-ment within the meaning of section 513(i) and 1.5134, that Ms advertising activity is regularly carried on, and that the entire amount of the payment is unrelated business taxable income to M. Expenses directly con-nected with generating the unrelated busi-ness taxable income (i.e., direct advertising costs) total $25,000. Expenses directly con-nected with the preparation and publication of the exhibition catalog (other than direct advertising costs) total $110,000. M receives $60,000 of gross revenue from sales of the ex-hibition catalog. Expenses directly con-nected with the conduct of the exhibition total $500,000. (ii) The computation of unrelated business taxable income is as follows: (A) Unrelated trade or business (sale of advertising): Income ............................... $100,000 ................Directly-connected ex-penses ........................... (25,000 ) ................Subtotal ...................... 75,000 $75,000 (B) Exempt function (publication of exhibition catalog): Income (from catalog sales) ............................. 60,000 ................VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00160 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150151 Internal Revenue Service, Treasury 1.512(a)1 Directly-connected ex-penses ........................... (110,000 ) ................Net exempt function income (loss) .......... (50,000 ) (50,000 ) Unrelated business taxable income ....... .................. 25,000 (iii) Expenses related to publication of the exhibition catalog exceed revenues by $50,000. Because the unrelated business activ-ity (the sale of advertising) exploits an ex-empt activity (the publication of the exhi-bition catalog), and because the publication of editorial material is an activity normally conducted by taxable entities that sell ad-vertising, the net loss from the exempt pub-lication activity is allowed as a deduction from unrelated business income under para-graph (d)(2) of this section. In contrast, the presentation of an exhibition is not an activ-ity normally conducted by taxable entities engaged in advertising and publication activ-ity for purposes of paragraph (d)(2) of this section. Consequently, the $500,000 cost of presenting the exhibition is not directly con-nected with the conduct of the unrelated ad-vertising activity and does not have a proxi-mate and primary relationship to that activ-ity. Accordingly, M has unrelated business taxable income of $25,000. (f) Determination of unrelated business taxable income derived from sale of adver-tising in exempt organization periodi-cals(1) In general. Under section 513 (relating to the definition of unrelated trade or business) and 1.5131, amounts realized by an exempt organi-zation from the sale of advertising in a periodical constitute gross income from an unrelated trade or business ac-tivity involving the exploitation of an exempt activity; namely, the circula-tion and readership of the periodical developed through the production and distribution of the readership content of the periodical. Paragraph (d) of this section provides for the allowance of deductions attributable to the produc-tion and distribution of the readership content of the periodical. Thus, subject to the limitations of paragraph (d)(2) of this section, where the circulation and readership of an exempt organization periodical are utilized in connection with the sale of advertising in the peri-odical, expenses, depreciation, and similar items of deductions attrib-utable to the production and distribu-tion of the editorial or readership con-tent of the periodical shall qualify as items of deductions directly connected with the unrelated advertising activ-ity. Subparagraphs (2) through (6) of this paragraph provide rules for deter-mining the amount of unrelated busi-ness taxable income attributable to the sale of advertising in exempt organiza-tion periodicals. Subparagraph (7) of this paragraph provides rules for deter-mining when the unrelated business taxable income of two or more exempt organization periodicals may be deter-mined on a consolidated basis. (2) Computation of unrelated business taxable income attributable to sale of ad-vertising(i) Excess advertising costs. If the direct advertising costs of an ex-empt organization periodical (deter-mined under subparagraph (6)(ii) of this paragraph) exceed gross advertising in-come (determined under subparagraph (3)(ii) of this paragraph), such excess shall be allowable as a deduction in de-termining unrelated business taxable income from any unrelated trade or business activity carried on by the or-ganization. (ii) Excess advertising income. If the gross advertising income of an exempt organization periodical exceeds direct advertising costs, paragraph (d)(2) of this section provides that items of de-duction attributable to the production and distribution of the readership con-tent of an exempt organization peri-odical shall qualify as items of deduc-tion directly connected with unrelated advertising activity in computing the amount of unrelated business taxable income derived from the advertising activity to the extent that such items exceed the income derived from or at-tributable to such production and dis-tribution, but only to the extent that such items do not result in a loss from such advertising activity. Further-more, such items of deduction shall not qualify as directly connected with such advertising activity to the extent that their deduction would result in a loss carryback or carryover with respect to such advertising activity. Similarly, such items of deduction shall not be taken into account in computing unre-lated business taxable income attrib-utable to any unrelated trade or busi-ness activity other than such adver-tising activity. Thus: (a) If the circulation income of the periodical (determined under subpara-graph (3)(iii) of this paragraph) equals VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00161 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150152 26 CFR Ch. I (4113 Edition) 1.512(a)1 or exceeds the readership costs of such periodical (determined under subpara-graph (6)(iii) of this paragraph), the un-related business taxable income attrib-utable to the periodical is the excess of the gross advertising income of the pe-riodical over direct advertising costs; but (b) If the readership costs of an ex-empt organization periodical exceed the circulation income of the peri-odical, the unrelated business taxable income is the excess, if any, of the total income attributable to the peri-odical (determined under subparagraph (3) of this paragraph) over the total pe-riodical costs (as defined in subpara-graph (6)(i) of this paragraph) See subparagraph (7) of this paragraph for rules relating to the consolidation of two or more periodicals. (iii) Examples. The application of this paragraph may be illustrated by the following examples. For purposes of these examples it is assumed that the production and distribution of the readership content of the periodical is related to the organizations exempt purpose. Example 1. X, an exempt trade association, publishes a single periodical which carries advertising. During 1971, X realizes a total of $40,000 from the sale of advertising in the pe-riodical (gross advertising income) and $60,000 from the sales of the periodical to members and nonmembers (circulation in-come). The total periodical costs are $90,000 of which $50,000 is directly connected with the sale and publication of advertising (di-rect advertising costs) and $40,000 is attrib-utable to the production and distribution of the readership content (readership costs). Since the direct advertising costs of the peri-odical ($50,000) exceed gross advertising in-come ($40,000), pursuant to subdivision (i) of this subparagraph, the unrelated business taxable income attributable to advertising is determined solely on the basis of the income and deductions directly connected with the production and sale of the advertising: Gross advertising revenue ................................. $40,000 Direct advertising costs ..................................... (50,000) Loss attributable to advertising .......................... (10,000) X has realized a loss of $10,000 from its adver-tising activity. This loss is an allowable de-duction in computing Xs unrelated business taxable income derived from any other unre-lated trade or business activity. Example 2. Assume the facts as stated in example 1, except that the circulation in-come of X periodical is $100,000 instead of $60,000, and that of the total periodical costs, $25,000 are direct advertising costs, and $65,000 are readership costs. Since the cir-culation income ($100,000) exceeds the total readership costs ($65,000), pursuant to sub-division (ii)(a) of this subparagraph the unre-lated business taxable income attributable to the advertising activity is $15,000, the ex-cess of gross advertising income ($40,000) over direct advertising costs ($25,000). Example 3. Assume the facts as stated in example 1, except that of the total periodical costs, $20,000 are direct advertising costs and $70,000 are readership costs. Since the reader-ship costs of the periodical ($70,000), exceed the circulation income ($60,000), pursuant to subdivision (ii) (b) of this subparagraph the unrelated business taxable income attrib-utable to advertising is the excess of the total income attributable to the periodical over the total periodical costs. Thus, X has unrelated business taxable income attrib-utable to the advertising activity of $10,000 ($100,000 total income attributable to the pe-riodical less $90,000 total periodical costs). Example 4. Assume the facts as stated in example 1, except that the total periodical costs are $120,000 of which $30,000 are direct advertising costs and $90,000 are readership costs. Since the readership costs of the peri-odical ($90,000), exceed the circulation in-come ($60,000), pursuant to subdivision (ii) (b) of this subparagraph the unrelated business taxable income attributable to advertising is the excess, if any, of the total income attrib-utable to the periodical over the total peri-odical costs. Since the total income of the periodical ($100,000) does not exceed the total periodical costs ($120,000), X has not derived any unrelated business taxable income from the advertising activity. Further, only $70,000 of the $90,000 of readership costs may be deducted in computing unrelated business taxable income since as provided in subdivi-sion (ii) of this subparagraph, such costs may be deducted, to the extent they exceed cir-culation income, only to the extent they do not result in a loss from the advertising ac-tivity. Thus, there is no loss from such activ-ity, and no amount may be deducted on this account in computing Xs unrelated trade or business income derived from any other un-related trade or business activity. (3) Income attributable to exempt orga-nization periodicals(i) In general. For purposes of this paragraph the total in-come attributable to an exempt organi-zation periodical is the sum of its gross advertising income and its circulation income. (ii) Gross advertising income. The term gross advertising income means all amounts derived from the unrelated VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00162 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150153 Internal Revenue Service, Treasury 1.512(a)1 advertising activities of an exempt or-ganization periodical (or for purposes of this paragraph in the case of a tax-able organization, all amounts derived from the advertising activities of the taxable organization). (iii) Circulation income. The term cir-culation income means the income at-tributable to the production, distribu-tion or circulation of a periodical (other than gross advertising income) including all amounts realized from or attributable to the sale or distribution of the readership content of the peri-odical, such as amounts realized from charges made for reprinting or repub-lishing articles and special items in the periodical and amounts realized from sales of back issues. Where the right to receive an exempt organization peri-odical is associated with membership or similar status in such organization for which dues, fees or other charges are received (hereinafter referred to as membership receipts), circulation income includes the portion of such member-ship receipts allocable to the periodical (hereinafter referred to as allocable membership receipts). Allocable member-ship receipts is the amount which would have been charged and paid if: (a) The periodical was that of a tax-able organization. (b) The periodical was published for profit, and (c) The member was an unrelated party dealing with the taxable organi-zation at arms length See subparagraph (4) of this paragraph for a discussion of the factors to be considered in determining allocable membership receipts of an exempt or-ganization periodical under the stand-ard described in the preceding sen-tence. (4) Allocable membership receipts. The allocable membership receipts of an ex-empt organization periodical shall be determined in accordance with the fol-lowing rules: (i) Subscription price charged to non-members. If 20 percent or more of the total circulation of a periodical consist of sales to nonmembers, the subscrip-tion price charged to such nonmembers shall determine the price of the peri-odical for purposes of allocating mem-bership receipts to the periodical. (ii) Subscription price to nonmembers. If paragraph (f)(4)(i) of this section does not apply and if the membership dues from 20 percent or more of the mem-bers of an exempt organization are less than those received from the other members because the former members do not receive the periodical, the amount of the reduction in member-ship dues for a member not receiving the periodical shall determine the price of the periodical for purposes of allo-cating membership receipts to the peri-odical. (iii) Pro rata allocation of membership receipts. Since it may generally be as-sumed that membership receipts and gross advertising income are equally available for all the exempt activities (including the periodical) of the organi-zation, the share of membership re-ceipts allocated to the periodical, where paragraphs (f)(4) (i) and (ii) of this section do not apply, shall be an amount equal to the organizations membership receipts multiplied by a fraction the numerator of which is the total periodical costs and the denomi-nator of which is such costs plus the cost of other exempt activities of the organization. For example, assume that an exempt organization has total periodical costs of $30,000 and other ex-empt costs of $70,000. Further assume that the membership receipts of the or-ganization are $60,000 and that para-graphs (f)(4) (i) and (ii) of this section do not apply. Under these cir-cumstances $18,000 ($60,000 times $30,000/$100,000) is allocated to the peri-odicals circulation income. (5) Examples. The rules set forth in paragraph (f)(4) of this section may be illustrated by the following examples. For purposes of these examples it is as-sumed that the exempt organization periodical contains advertising, and that the production and distribution of the readership content of the periodical is related to the organizations exempt purpose. Example 1. U is an exempt scientific organi-zation with 10,000 members who pay annual dues of $15 per year. One of Us activities is the publication of a monthly periodical which is distributed to all of its members. U also distributes 5,000 additional copies of its periodical to nonmember subscribers at a cost of $10 per year. Pursuant to paragraph (f)(4)(i) of this section, since the nonmember VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00163 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150154 26 CFR Ch. I (4113 Edition) 1.512(a)1 circulation of Us periodical represents 3313 percent of its total circulation the subscrip-tion price charged to nonmembers will be used to determine the portion of Us mem-bership receipts allocable to the periodical. Thus, Us allocable membership receipts will be $100,000 ($10 times 10,000 members), and Us total circulation income for the peri-odical will be $150,000 ($100,000 from members plus $50,000 from sales to nonmembers). Example 2. Assume the facts as stated in example 1, except that U sells only 500 copies of its periodical to nonmembers, at a price of $10 per year. Assume further that Us mem-bers may elect not to receive the periodical, in which case their annual dues are reduced from $15 per year to $6 per year, and that only 3,000 members elect to receive the peri-odical and pay the full dues of $15 per year. Us stated subscription price to members of $9 consistently results in an excess of total income (including gross advertising income) attributable to the periodical over total costs of the periodical. Since the 500 copies of the periodical distributed to nonmembers represents only 14 percent of the 3,500 copies distributed, pursuant to paragraph (f)(4)(i) of this section, the $10 subscription price charged to nonmembers will not be used in determining the portion of membership re-ceipts allocable to the periodical. On the other hand, since 70 percent of the members elect not to receive the periodical and pay $9 less per year in dues, pursuant to paragraph (f)(4)(ii) of this section, such $9 price will be used in determining the subscription price charged to members. Thus, the allocable membership receipts will be $9 per member, or $27,000 ($9 times 3,000 copies) and Us total circulation income will be $32,000 ($27,000 plus $5,000). Example 3. (a) W, an exempt trade associa-tion, has 800 members who pay annual dues of $50 per year. W publishes a monthly jour-nal the editorial content and advertising of which are directed to the business interests of its own members. The journal is distrib-uted to all of Ws members and no receipts are derived from nonmembers. (b) W has total receipts of $100,000 of which $40,000 ($50800) are membership receipts and $60,000 are gross advertising income. Ws total costs for the journal and other exempt activities is $100,000. W has total periodical costs of $76,000 of which $41,000 are direct ad-vertising costs and $35,000 are readership costs. (c) Paragraph (f)(4)(i) of this section will not apply since no copies are available to nonmembers. Therefore, the allocation of membership receipts shall be made in ac-cordance with paragraph (f)(4)(iii) of this sec-tion. Based upon pro rata allocation of mem-bership receipts (40,000) by a fraction the nu-merator of which is total periodical costs ($76,000) and the denominator of which is the total costs of the journal and the other ex-empt activities ($100,000), $30,400 ($76,000/ $100,000 times $40,000) of membership receipts is circulation income. (6) Deductions attributable to exempt organization periodicals(i) In general. For purposes of this paragraph the term total periodical costs means the total deductions attributable to the pe-riodical. For purposes of this paragraph the total periodical costs of an exempt organization periodical are the sum of the direct advertising costs of the peri-odical (determined under subdivision (ii) of this subparagraph) and the read-ership costs of the periodical (deter-mined under subdivision (iii) of this subparagraph). Items of deduction properly attributable to exempt activi-ties other than the publication of an exempt organization periodical may not be allocated to such periodical. Where items are attributable both to an exempt organization periodical and to other activities of an exempt organi-zation, the allocation of such items must be made on a reasonable basis which fairly reflects the portion of such item properly attributable to each such activity. The method of allocation will vary with the nature of the item, but once adopted, a reasonable method of allocation with respect to an item must be used consistently. Thus, for example, salaries may generally be al-located among various activities on the basis of the time devoted to each activ-ity; occupancy costs such as rent, heat and electricity may be allocated on the basis of the portion of space devoted to each activity; and depreciation may be allocated on the basis of space occupied and the portion of the particular asset utilized in each activity. Allocations based on dollar receipts from various exempt activities will generally not be reasonable since such receipts are usu-ally not an accurate reflection of the costs associated with activities carried on by exempt organizations. (ii) Direct advertising costs. (a) The di-rect advertising costs of an exempt or-ganization periodical include all ex-penses, depreciation, and similar items of deduction which are directly con-nected with the sale and publication of advertising as determined in accord-ance with paragraphs (a), (b), and (c) of this section. These items are allowable as deductions in the computation of VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00164 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150155 Internal Revenue Service, Treasury 1.512(a)1 unrelated business income of the orga-nization for the taxable year to the ex-tent they meet the requirements of section 162, section 167, or other rel-evant provisions of the Code. The items allowable as deductions under this sub-division do not include any items of de-duction attributable to the production or distribution of the readership con-tent of the periodical. (b) The items allowable as deductions under this subdivision would include agency commissions and other direct selling costs, such as transportation and travel expenses, office salaries, promotion and research expenses, and direct office overhead directly con-nected with the sale of advertising lin-eage in the periodical. Also included would be other items of deduction com-monly classified as advertising costs under standard account classification, such as art work and copy preparation, telephone, telegraph, postage, and similar costs directly connected with advertising. (c) In addition to the items of deduc-tion normally included in standard ac-count classifications relating to adver-tising costs, it is also necessary to as-certain the portion of mechanical and distribution costs attributable to ad-vertising lineage. For this purpose, the general account classifications of items includible in mechanical and dis-tribution costs ordinarily employed in business-paper and consumer publica-tion accounting provide a guide for the computation. Thus, the mechanical and distribution costs in such cases would include the portion of the costs and other expenses of composition, presswork, binding, mailing (including paper and wrappers used for mailing), and the bulk postage attributable to the advertising lineage of the publica-tion. The portion of mechanical and distribution costs attributable to ad-vertising lineage of the periodical will be determined on the basis of the ratio of advertising lineage to total lineage of the periodical, and the application of that ratio to the total mechanical and distribution costs of the periodical, where records are not kept in such a manner as to reflect more accurately the allocation of mechanical and dis-tributions costs to advertising lineage of the periodical, and where there is no factor in the character of the peri-odical to indicate that such an alloca-tion would be unreasonable. (iii) Readership costs. The readership costs of an exempt organization peri-odical include expenses, depreciation or similar items which are directly connected with the production and dis-tribution of the readership content of the periodical and which would other-wise be allowable as deductions in de-termining unrelated business taxable income under section 512 and the regu-lations thereunder if such production and distribution constituted an unre-lated trade or business activity. Thus, readership costs include all the items of deduction attributable to an exempt organization periodical which are not allocated to direct advertising costs under subdivision (ii) of this subpara-graph, including the portion of such items attributable to the readership content of the periodical, as opposed to the advertising content, and the por-tion of mechanical and distribution costs which is not attributable to ad-vertising lineage in the periodical. (7) Consolidation(i) In general. Where an exempt organization subject to un-related business income tax under sec-tion 511 publishes two or more periodi-cals for the production of income, it may treat the gross income from all (but not less than all) of such periodi-cals and the items of deduction di-rectly connected with such periodicals (including readership costs of such periodicals), on a consolidated basis as if such periodicals were one periodical in determining the amount of unre-lated business taxable income derived from the sale of advertising in such pe-riodical. Such treatment must, how-ever, be followed consistently and once adopted shall be binding unless the consent of the Commissioner is ob-tained as provided in sections 446(e) and 1.4461(e). (ii) Production of income. For purposes of this subparagraph, an exempt orga-nization periodical is published for the production of income if: (a) The organization generally re-ceives gross advertising income from the periodical equal to at least 25 per-cent of the readership costs of such pe-riodical, and VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00165 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150156 26 CFR Ch. I (4113 Edition) 1.512(a)1 (b) The publication of such periodical is an activity engaged in for profit For purposes of the preceding sentence, the determination whether the publica-tion of a periodical is an activity en-gaged in for profit is to be made by ref-erence to objective standards taking into account all the facts and cir-cumstances involved in each case. The facts and circumstances must indicate that the organization carries on the ac-tivity with the objective that the pub-lication of the periodical will result in economic profit (without regard to tax consequences), although not nec-essarily in a particular year. Thus, an exempt organization periodical may be treated as having been published with such an objective even though in a par-ticular year its total periodical costs exceed its total income. Similarly, if an exempt organization begins pub-lishing a new periodical, the fact that the total periodical costs exceed the total income for the startup years be-cause of a lack of advertising sales does not mean that the periodical was pub-lished without an objective of eco-nomic profit. The organization may es-tablish that the activity was carried on with such an objective. This might be established by showing, for example, that there is a reasonable expectation that the total income, by reason of an increase in advertising sales, will ex-ceed costs within a reasonable time. See 1.1832 for additional factors bear-ing on this determination. (iii) Example. This subparagraph may be illustrated by the following exam-ple: Example. Y, an exempt trade association, publishes three periodicals which it distrib-utes to its members: a weekly newsletter, a monthly magazine, and quarterly journal. Both the monthly magazine and the quar-terly journal contain advertising which ac-counts for gross advertising income equal to more than 25 percent of their respective readership costs. Similarly, the total income attributable to each such periodical has ex-ceeded the total deductions attributable to each such periodical for substantially all the years they have been published. The news-letter carries no advertising and its annual subscription price is not intended to cover the cost of publication. The newsletter is a service of Y distributed to all of its members in an effort to keep them informed of changes occurring in the business world and is not engaged in for profit. Under these cir-cumstances, Y may consolidate the income and deductions from the monthly and quar-terly journals in computing its unrelated business taxable income, but may not con-solidate the income and deductions attrib-utable to the publication of the newsletter with the income and deductions of its other periodicals since the newsletter is not pub-lished for the production of income. (g) Foreign organizations(1) In gen-eral. The unrelated business taxable in-come of a foreign organization exempt from taxation under section 501(a) con-sists of: (i) The organizations unrelated busi-ness taxable income which is derived from sources within the United States but which is not effectively connected with the conduct of a trade or business within the United States, plus (ii) The organizations unrelated business taxable income effectively connected with the conduct of a trade or business within the United States (whether or not such income is derived from sources within the United States) To determine whether income realized by a foreign organization is derived from sources within the United States or is effectively connected with the conduct of a trade or business within the United States, see part 1, sub-chapter N, chapter 1 of the Code (sec-tion 861 and following) and the regula-tions thereunder. (2) Effective dates. Subparagraph (1) of this paragraph applies to taxable years beginning after December 31, 1969. For taxable years beginning on or before December 31, 1969, the unrelated busi-ness taxable income of a foreign orga-nization exempt from taxation under section 501(a) consists of the organiza-tions unrelated business taxable in-come which: (i) For taxable years beginning after December 31, 1966, is effectively con-nected with the conduct of a trade or business within the United States, whether or not such income is derived from sources within the United States; (ii) For taxable years beginning on or before December 31, 1966, is derived from sources within the United States. (h) Effective date. Paragraphs (a) through (f) of this section are applica-ble with respect to taxable years begin-ning after December 12, 1967. However, VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00166 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150157 Internal Revenue Service, Treasury 1.512(a)4 if a taxpayer wishes to rely on the rules stated therein for taxable years beginning before December 13, 1967, he may do so. [T.D. 7392, 40 FR 58638, Dec. 18, 1975, as amended by T.D. 7438, 41 FR 44392, Oct. 8, 1976; T.D. 7935, 49 FR 1694, Jan. 13, 1984; T.D. 8991, 67 FR 20437, Apr. 25, 2002] 1.512(a)2 Definition applicable to taxable years beginning before De-cember 13, 1967. (a) In general. The unrelated business taxable income which is subject to the tax imposed by section 511 is the gross income, derived by any organization to which section 511 applies, from any un-related trade or business regularly car-ried on by it, less the deductions al-lowed by chapter 1 of the Code which are directly connected with the car-rying on of such trade or business, sub-ject to certain exceptions, additions, and limitations referred to below. In the case of an organization which regu-larly carries on two or more unrelated businesses, its unrelated business tax-able income is the aggregate of its gross income from all such unrelated businesses, less the aggregate of the de-ductions allowed with respect to all such unrelated businesses. For provi-sions generally applicable to the unre-lated business tax, see 1.5113, and for rules applicable to the determination of the adjusted basis of property, see paragraph (a)(2) of 1.514(a)1. (b) Effective date. Except as provided in paragraph (f) of 1.512(a)1, this sec-tion is applicable with respect to tax-able years beginning before December 13, 1967. [T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6939, 32 FR 17660, Dec. 12, 1967] 1.512(a)3 [Reserved] 1.512(a)4 Special rules applicable to war veterans organizations. (a) In general. For taxable years be-ginning after December 31, 1969, this section provides special rules for the determination of the unrelated busi-ness taxable income of an organization described in section 501(c)(19). In gen-eral, the rules contained in sections 511 through 514 which are applicable to any organization listed in section 501(c) apply in determining the unrelated business taxable income of an organiza-tion described in section 501(c)(19). However, that amount which is paid by members to the organization for the purpose described in paragraph (b)(1) of this section, if set aside from other or-ganizational monies and accounts in an insurance set aside, may be excluded from the unrelated business taxable in-come of the organization. The insur-ance set aside shall be used exclusively for providing insurance benefits, for the purposes specified in section 170(c)(4) of the Code, for the reasonable costs of administering the insurance program that are directly related to such set aside, or for the reasonable costs of distributing funds for section 170(c)(4) purposes. If an amount so set aside is used for any purposes other than those described in the preceding sentence, it shall be included in unre-lated business taxable income without regard to any modifications provided by section 512(b), in the taxable year in which it is withdrawn from such set aside. Amounts will be considered to have been withdrawn from an insur-ance set aside if they are used in any manner inconsistent with providing in-surance benefits, paying the reasonable costs of administering the insurance program for section 170(c)(4) purposes and for costs of distributing funds for section 170(c)(4) purposes. An example of a use of funds which would be con-sidered a withdrawal would be the use of such funds as security for a loan. (b) Insurance set aside(1) Purpose of payments by members. Payments by members (including commissions on such payments earned by the set aside as agent for an insurance company) into an insurance set aside must be for the sole purpose of obtaining life, sick, accident or health insurance benefits from the organization or for the rea-sonable costs of administration of the insurance program, except that such purpose is not violated when excess funds from an experience gain are uti-lized for those purposes specified in section 170(c)(4) or the reasonable costs of distributing funds for such purposes. Funds for any other purpose may not be set aside in the insurance set aside. (2) Income from set aside. In addition to the payments by members described VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00167 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150158 26 CFR Ch. I (4113 Edition) 1.512(a)5T in paragraph (b)(1) of this section, only income from amounts in the insurance set aside (including commissions earned as agent for an insurance com-pany) may be so set aside. Moreover unless such income is used for pro-viding insurance benefits, for those purposes specified in section 170(c)(4), or for reasonable costs of administra-tion, such income must be set aside within the period described in para-graph (b)(3) of this section in order to avoid being included as an item of un-related business taxable income under section 512(a)(4). (3) Time within which income must be set aside. Income from amounts in the insurance set aside generally must be set aside in the taxable year in which it would be includible in gross income but for this section. However, income set aside on or before the date pre-scribed for filing the organizations re-turn of unrelated business taxable in-come (whether or not it had such in-come) for the taxable year (including any extension of time) may, at the election of the organization, be treated as having been set aside in such tax-able year. (4) Computation of income from set aside. Income from amounts in the in-surance set aside shall consist solely of items of investment income from, and other gains derived from dealings in, property in the set aside. The deduc-tions allowed against such items of in-come or other gains are those amounts which are related to the production of such income or other gains. Only the amounts of income or other gain which are in excess of such deductions may be set aside in the insurance set aside. (5) Requirements for set aside. An amount is not properly set aside if the organization commingles it with any amount which is not to be set aside. However, adequate records describing the amount set aside and indicating that it is to be used for the designated purpose are sufficient. Amounts that are set aside need not be permanently committed to such use either under state law or by contract. Thus, for ex-ample, it is not necessary that the or-ganization place these funds in an ir-revocable trust. Although set aside in-come may be accumulated, any accu-mulation which is unreasonable in amount or duration is evidence that the income was not accumulated for the purposes set forth. For purposes of the preceding sentence, accumulations which are reasonably necessary for the purpose of providing life, sick, health, or accident insurance benefits on the basis of recognized mortality or mor-bidity tables and assumed rates of in-terest under an actuarially acceptable method would not be unreasonable even though such accumulations are quite large and the time between the receipt by the organization of such amounts and the date of payment of the benefits is quite long. For example, an accumulation of income for 20 years or longer which is determined to be reasonable necessary to pay life insur-ance benefits to members, their de-pendents or designated beneficiaries, generally would not be an unreasonable accumulation. Income which has been set aside may be invested, pending the action contemplated by the set aside, without being regarded as having been used for other purposes. [T.D. 7438, 41 FR 44393, Oct. 8, 1976] 1.512(a)5T Questions and answers relating to the unrelated business taxable income of organizations de-scribed in paragraphs (9), (17) or (20) of Section 501(c) (temporary). Q1: What does section 512(a)(3), as amend-ed by the Tax Reform Act of 1984 (Act), pro-vide with respect to organizations described in paragraphs (9), (17) or (20) of section 501(c)? A1: In general, section 512(a)(3), as amend-ed by section 511 of the Act, extends the rules for determining the unrelated business income tax of voluntary employees bene-ficiary associations (VEBAs) to supple-mental unemployment compensation benefit trusts (SUBs) and group legal service organi-zations (GLSOs). The section also restricts the amount of income that may be set aside by such organizations for exempt purposes. Q2: What is the effective date of the amendments to section 512(a)(3)? A2: The amendments to section 512(a)(3) will apply to income earned by VEBAs, SUBs or GLSOs after December 31, 1985, in the tax-able years of such organizations ending after such date. For purposes of applying section 512(a)(3) to the first taxable year of such an organization ending after December 31, 1985, the income of the VEBA, SUB or GLSO earned after December 31, 1985, will be deter-mined by allocating the total income earned VerDate Mar<15>2010 12:31 May 08, 2013 Jkt 229093 PO 00000 Frm 00168 Fmt 8010 Sfmt 8010 Q:\26\26V7.TXT ofr150 PsN: PC150159 Internal Revenue Service, Treasury 1.512(a)5T for such taxable year on the basis of the cal-endar year 1985 and 1986 months in such tax-able year. However, if a VEBA, SUB or GLSO is part of a plan that is maintained pursuant to one or more collective bargaining agree-ments (a) between employee representatives and one or more employers, and (b) which are in effect on July 1, 1985 (or ratified on or before that date), the amendments do not apply to income earned in a taxable year of a VEBA, SUB or GLSO beginning before the termination of the last of the collective bar-gaining agreements pursuant to which the plan is maintained (determined without re-gard to any extension of the contract agreed to after July 1, 1985). For purposes of the pre-ceding sentence, any plan amendment made pursuant to a collective bargaining agree-ment relating to the plan which amends the plan solely to conform to any requirement added under section 511 of the Tax Reform Act 1984 (i.e., requirements under section 419, 419A, 512(a)(3)(E), and 4976) shall not be treat-ed as a termination of such collective bar-gaining agreements. Q3: What amount of income may a VEBA, SUB or GLSO set aside for exempt purposes? A3: (a) Pursuant to section 512(a)(3)(E)(i), the amounts set as